Fool.com: Woo Hoo! The Market's Falling (Fool On the Hill) August 3, 1999

FOOL ON THE HILL
An Investment Opinion

Woo Hoo! The Market's Falling

By Warren Gump (TMF Gump) (TMF Gump)
August 3, 1999

That headline probably sounds perverse, but rest assured, I'm an investor in the market along with most of you. Many of the stocks in my portfolio have been hit by the infection of higher interest rates and investor fear that has eaten away at so many stocks over the past few weeks. Nonetheless, the market tumble is actually starting to make me feel a little better. Falling stock prices may not satisfy the need for instant gratification desired by so many Americans, but most investors should be enthused to see valuations lowered -- so long as you are continuing to invest and are buying at lower prices.

Consider a search to find a nice new bed to enliven your house or apartment. You take lots of time looking at different stores, trying to get an idea of what best fits your preferences. Once you find the right one, you'll likely look around to find the most cost-effective way to purchase the product. Oftentimes, if your shopping spree is anything like my own, the item you really want exceeds your budget (think queen-sized, cherry wood sleigh bed).

A couple of options are available to overcome this situation. You can pay more than budgeted and eat Ramen noodles for lunch and dinner while paying off your excess debt. Or a more palatable choice would be to find another bed that meets most of your desires, but falls within an affordable price range. Another option, probably the best assuming it's feasible, would be to hold onto that futon from college a little longer, and hope that the bed you want will go on sale or a better alternative emerges.

If pursuing option #3, the ideal situation is that the bed you want is quickly marked down to your price range so you can scoop it up. Any consumer knows that a sale is a great opportunity to acquire merchandise, as long as it is first quality and undamaged. With a reduced price, something that at one time seemed unattainable falls into the realm of possibility.

For some reason, people don't make the same analogy between this type of sale and stock prices. I think part of the problem is that many investors associate stock prices directly with how well a company is doing. When the price is going up, everything must be going well. Last November, when Books-A-Million (Nasdaq: BAMM) surged form $3 to $47, many people probably thought the company was doing great, even though most of its business was basically unchanged (it simply announced the opening of a Web store).

Conversely, when a stock price stumbles for any reason, investors tend to fear that the "merchandise" is damaged. Looking at some of the big Internet stocks like America Online (NYSE: AOL) and Yahoo! (Nasdaq: YHOO), some investors fear fundamental problems because the companies have seen their stock prices fall around 50% from their peak prices earlier this year. Never mind that both firms continue to post excellent results and their stock prices are up several-fold from the beginning of 1998.

Investors should not directly correlate stock price performance with business fundamentals. While these two items track each other quite nicely over longer time frames, investor emotions often cause divergence over short time periods. An investor needs to stay focused on whether a company is proceeding on a path that will likely result in profitable future growth. We can never forecast exactly what will happen, but we can imagine probable outcomes based on a company's market and financial position vis-a-vis its competitors.

My sleigh beds of investing are Yahoo! and America Online, two leaders in the Internet space that have dominant positions and highly leveragable business models. Despite my desire to own these companies, I have not seriously considered them as investments since other investors have been so euphoric about their prospects. (While some may interpret that statement as a boast about missing the recent Internet stock downdraft, in reality it is an admission that I've completely missed the boat on the best investment opportunity thus far in my lifetime.)

Even for a fairly devoted value/growth-at-a-reasonable price investor, it has been hard to sit on the Internet sidelines. A business model with such leverage is extraordinarily attractive during a period of exponential growth. It makes my companies growing earnings at 15%-25% per year pale in comparison. Nonetheless, Yahoo! and America Online have simply been out of my budget's reach. Even with the pullback over the past few months, these two stocks are trading for 349x and 182x, respectively, earnings estimates for calendar 1999. Future growth could make those prices seem reasonable -- or even cheap -- at a later date, but right now they are still too dear for me.

Based on the recent price drop, though, I'm going to once again start investigating these two companies after a two-year hiatus. Although the current valuations seem somewhat extravagant to me, there's no telling when they might hit what seems to be an attractive range. The stocks wouldn't necessarily have to fall further for this to happen. If underlying profitability improves faster than expected, the companies could also fall within my target zone. Before making that decision, I'll need to be aware of all the issues surrounding the companies. If I'm lucky, weak general market conditions and strong company performance will finally let me pick up one or two of these "Dream Team" stocks. Woo Hoo!