Economic Concerns: Internet stocks sorting out with a vengeance

If memory serves me right (which it doesn't always do these days), it was Carl Sandberg who wrote:

"Choose your words wisely,

Like an old woman over a bushel of apples."

Substitute for "word," either "investments" or "stocks," and you know what is going on in the markets now. The sorting out process is taking place with a vengeance.

Know what the following issues have in common?

GO.com; priceline.com; Drkoop.com; Etoys; TheStreet.com; VerticalNet; E*Trades; Ivillage.com; Stamps.com

A. They are all Internet stocks.

B. None of them has earnings.

C. They are all at least 60 percent below their 52-week high.

D. Two of them are down more than 90 percent from their 52-week high.

E. All of the above.

You guessed it; the correct answer is "E." Did I not say the sorting out was taking place with a vengeance?

What is going on here folks?

It is basic. Investors are separating the wheat from the chaff, while day traders and speculators are separating themselves from their money. The "new metric" (how quickly the "new paradigm" slipped from linguistic favor!) that says earnings don't matter has gone 10 rounds with the champion and had the bejabbers beaten out of him.

The inexperienced market participants (notice I do not call them investors) who became caught up in dot-com mania drove prices of many money-losing Internet companies up a parabolic curve. Then they learned the lesson (as each generation of self-professed, but inexperienced, geniuses must), that guess what what goes up can come down.

In spite of what we have written about, addressed at numerous speaking engagements and counseled one-on-one, even we have had clients, friends and relatives who have champed at the bit to ride the Internet momentum to certain profits.

One relative, whom I'll call Kel (because that's his name), wanted to take money in January that was set aside for taxes and try to double it by April 17th. Fortunately, we were able to dissuade him. His investment of choice at the time was a company called Macromedia, trading at $88. On April 17th it closed at $50, and that was without benefit of a stock split.

A bad company? No, but with the stock selling at 100 times next year's earnings it was (and still is) vulnerable to violent swings in choppy markets. Who knows, long term it may well be the Microsoft of its industry, but it is not the kind of issue in which to put short-term tax reserves.

Am I pooh-poohing the technology era? Certainly not. What I am saying is simply that a serious investor who wants to participate in technology should not abandon a rational approach to stock selection. In the long run, only two things determine stock prices earnings and how many dollars an investor must pay for a dollar's worth of earnings (often referred to as a P/E ratio, but I prefer my definition).

Are you a serious investor who wants to get just a bit crazy and play the Internet or technology game with the day traders and the momentum boys? OK, allocate a small percentage of your portfolio to that, but not more than 10 percent. Have fun, but remember two things: 1. Don't confuse brains with a bull market or a couple of lucky trades, and 2. Don't say I didn't warn you.

P.S. Check out the article on behavioral finance, "You Are What You Trade," in the current issue of Bloomberg Personal Finance magazine, and see if you recognize someone. Don't get that magazine? Drop me a line and I'll send you a copy of the article.

P.P.S. I'll be in Springfield the third week of June. Anybody need a bad golfer for his or her foursome?

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Questions or comments can be directed to him by mail via The Springfield Business Journal, 313 Park Central West, 65806 or by e-mail at sbj@sbj.net.)