FOOL ON THE HILL
An Investment Opinion
The Death of Tech? Bill Mann (TMF Otter)
January 31, 2000
Here we are, on the cusp of the big "correction" that many pundits have been calling for, and with it the death of tech stocks and their mighty valuations.
No such thing will happen. And even if the market does turn downward for a period of time, there's no rolling back the sea change that computers, the Internet, and wireless communications have wrought upon our economy. Can't be done, will not happen. That is one genie that cannot be put back in the bottle.
We're not going to be forsaking our advanced communications or the companies that best make use of (or provide them) anytime soon. The Luddites who are hoping and praying for the bear market to come and mop up some of the highest flyers of the last few years miss this one point rather badly. Qualcomm (Nasdaq: QCOM), for whatever irrational reasons for its run up, is situated on a spot where companies will have to pay them for a service that consumers demand. No amount of short-term shellacking in the marketplace will take away this fact. The basic question is one of valuation of the potential of that technology. Given the rapid change of technology in the sector, this potential is quite difficult to gauge.
But there can be no question that at some point these industries will make the transition from being the "Rule Breaking" disruptors of the status quo to being the ones having to protect themselves from the new interlopers. When this occurs, some of the most beloved companies of today will become irrelevant relics, forgotten detritus on the slag heap of history. Fools who pretend that this will not happen only heighten the prospect that they will be holding one of the stones when it sinks. Once upon a time such stalwarts as Wang Laboratories, Hayes Corporation and Digital were where Broadcom (Nasdaq: BRCM), Nokia (NYSE: NOK), and JDS Uniphase (Nasdaq: JDSU) stand now, with world beating technology and Wall Street dabbing their feet with rosewater. Something changed, for some reason these companies lost their leads.
How do we determine in advance which companies will fail to make the transition? For starters we could call the 'Psychic Hotline,' but beyond any dependence on soothsaying it remains difficult to predict the future. The future is a series of events -- which until they actually take place are only predictable in their randomness. But Fools do have some ability to see into the future, if we choose to focus on the right things. In order to do so, we must ignore the market prices and concentrate on the underlying businesses and their prospects.
We also need to blow up a simple generalization made by Wall Street. The appellation of "tech stock" is completely dismissive to the fact that companies do not move as a united front. This does a grave disservice to investors, who, in seeking to invest in "tech stocks," may in fact go chasing companies that have no prospect of future success.
Besides, just what is a "tech" company? How is Amazon.com (Nasdaq: AMZN), a purveyor of books and other consumer goods, more of a high tech company than USEC (NYSE: USU), the largest producer of enriched uranium? Because it does business over the Internet? In the 1930s, was every company with its own telephone a communications company?
But I digress. Ignore share prices and concentrate on the businesses. This is admittedly tough to do, but it is also a must for successful long-term investing. Although a rising stock price is a nice sign of the health of a business, it is by no means symptomatic. Sometimes the best companies on the planet can go years without much share price appreciation. For example, Motorola (NYSE: MOT) has increased by 7500% over a 20-ear period, but did not appreciate at all for the 5 year period between January 1994 and January 1999. And Wal-Mart (NYSE: WMT), though not a "tech company," went from mid-1991 to mid-1997 without any appreciation of shareholder value. Is this the sign of a bad company? You tell me, are Motorola and Wal-Mart bad companies, ones without potential for future profit growth?
All great businesses have times of decline or level share pricing. For the Foolish investor, this should not be the greatest concern. If a company you have invested in shows trends toward increasing sales, high gross and net margins, excellent prospects for future growth, a leading and/or increasing portion of the business in its sector, and good cash management, you've more likely than not got a winner. If you find a business with these attributes and you buy and hold on through thick and thin, you've already won, regardless of whether the market has chosen to reward you or not. Market risk only becomes so when you allow fear or greed to overrun principles in making investment decisions.
The successful long-term investor chooses benchmarks in advance (for example, the Rule Maker or Rule Breaker criteria), only buys companies that exceeds them, and sells any company holding that violates them. Principled investing will not make you impervious to mistakes, but it will help you sleep at night, even when the market has chosen to punish the companies you hold.
The investing public goes through fads, cycles, and even manias. It is very well possible that we are in a mania right now, as an unheard of level of unprofitable companies have been given significant valuations based upon perceived prospects of the future. In the end, there is one inviolable rule: companies have to make profits. Companies that are now given large valuations in spite of operating losses are fundamentally only treated thusly based upon their potential to become very profitable in the future. Amazon and other maturing Internet companies will not be allowed to remain unprofitable forever with impunity by the market.
We'll likely only know in hindsight whether or not the current high-flyers of the stock market are in fact "overvalued." The answer will most certainly be "yes" for some of them, and "not even close" for others. But the fact is that a new plane for economic expansion has been created, and a certain subset of the companies that are exploiting the "Internet Territory" will achieve growth levels unseen in previous generations.
Many of the pundits declaring the imminent crash have assumed companies must come back to traditional valuations. But information technology has allowed inventory levels, work-in-progress timeframes, and payment cycles to be compressed to a level unheard of even a decade ago. This basic change in economy and the technology that makes it possible cannot be undone, regardless of the current sentiment of the market, or the cries of "foul" among economists.
Technology stock "crash." Maybe, but it won't be fatal, and it won't unring the bell of New Economic change.
Bill Mann, TMFOtter on the boards