Are Stocks Glorified Commodities?[Fool on the Hill] April 7, 2000

An Investment Opinion

Are Stocks Glorified Commodities?

By Bill Mann (TMF Otter)
April 7, 2000

I saw an interesting article in USA Today yesterday that plotted some coincidental movements between certain crop future prices in the past and the performance of some of the big growth companies and commodities. For example, the recent market performance of JDS Uniphase (Nasdaq: JDSU) is supposed to mimic the performance of soybean futures when they peaked in 1997, or Rambus (Nasdaq: RMBS) mimics lumber contracts from 1999, and some others resemble other futures pricing trends with remarkable accuracy.

The end result for each company, if the history of the futures contracts they are purported to match is any indication, will be trouble, as these speculative binges ended with the commodity prices skyrocketing and then sinking back to the point near where they started, following a four month contraction in price.

Sure, OK. This strikes me as data mining at its absolute worst, technical analysis looking for immutable patterns from the past. A hint: there aren't any. But the speculative froth that has come up over these and other momentum stocks is undeniable, and as such there are some similarities about how "investors" look at the momentum stocks and the way speculators bid on futures.

The Motley Fool takes criticism from some sides for ignoring options as viable ways to invest in the market. I'd suggest that many of the companies that we cover, many of the biggest growth stories from the last two years, are futures contracts in and of themselves.

You want to discuss put or call options on Qualcomm (Nasdaq: QCOM)? Qualcomm itself may be priced like a commodity, priced not on company financial fundamentals, but on potential. It goes like this: Qualcomm is priced at 348 times earnings, but the basis of buying Qualcomm for some is a future contract on the potential for domination by CDMA technology, key patents for which are held by the company. If China announces they're going to adopt CDMA wireless standards, Qualcomm skyrockets. If they choose something else, it drops. To determine which reason you hold this stock, ask yourself this question: Do you intend to hold Qualcomm for the decade or so until it either fulfills its promise or fails? If not, you're playing Qualcomm as a momentum stock, if so, you're investing in it.

Futures work the same way as I have described above. Let's say you believe that the price of Frozen Concentrated Orange Juice (with all due respect to Trading Places) is going to go up, due to weather conditions, demand curves, and so on. You could take a contract on OJ Futures maturing in three months. The majority of people who deal in futures contracts are never expecting to actually take delivery of the goods, they're hoping to sell the contracts sometime prior to maturity at a higher price.

In the same way, speculative runs on stocks are somewhat (or in some cases, totally) disconnected with the actual underlying business. Instead, they are caused in part by traders' belief that they will be able to make money on the direction of the stock price. This rationale goes a long way in helping me get my head around why a company like eBay (Nasdaq: EBAY) can go from $8 to $234 in six months, then back down to $70, then back up to $255, and once again back down again in the course of another year. There is a certain subset of investors who are treating these companies the same way they do futures, without having any intention to be around when the time comes for the company to deliver on its promise. There is no explanation based on company fundamentals that would convince me that these price movements were, even in hindsight, reflective of the underlying fundamentals for eBay.

I've wondered aloud in this space before how people can invest in companies with massive valuations when they have no revenues, or even assets. If this hypothesis holds water, the answer would be that people are not buying the companies -- no cash flow analysis would possibly support this -- but rather they are buying contracts on the potential that other people will covet the shares at a later point at a higher price.

If this is in fact the case, it provides all the more impetus for Foolish investors not to get caught up in the day-to-day of stock price movement. As with futures, speculative stock investing can amplify small changes in potential outcome into huge price swings.

E-nough is
A polite E-request and a recommendation to entrepreneurs entering into the information technology and Internet sectors. Call it "Advice from M2U." It is no longer clever to just add the letters "e," "i," or ".com" to a word to convey the business of the company. Investors have seen so many iTurfs, eLotterys, and drkoop.coms that these appellations are no longer E-quated with guaranteed appreciation and success.

What's more, they don't really describe very much. If I want to find a company on the Internet, the first thing I'm going to do is add ".com" to the end of the name. The ".com," then, is redundant. It describes nothing, and unless the word sitting in front of it is "amazon," it doesn't even represent anything all that earth-shattering anymore.

So, you're selling goats on the Internet? Are you a B2B vertically integrated Internet-enabled marketer of cleft-hoof garbage and grass-eating applications? Please don't be. That doesn't tell us anything. And please don't be eGoats, iGoats,, GoatNet, or even Clik2Goat -- they're just going to get lost in the shuffle of all of the other similarly named companies. You're an entrepreneur, and you're creative. You can do better.

Oh, and anyone who, in spite of my cyberequest (another no-no), still wants to name your goat providing service any of the above, just come ask me -- I've cybersquatted the URLs.

Momentum Stocks
Although I am no big fan of taking a snapshot, short-term window and declaring it a trend, particularly on the tail of a week of such volatility, I did notice that many of the companies that have grown so spectacularly over the last 2 years or so are down significantly year-to-date. While I'm not going to belabor the point on this, I did find it interesting that those people who piled in late on some of the most cited "new-economy" stocks find themselves significantly underwater so far this year. Some, but not all:

AOL (NYSE: AOL)                         -11%
Yahoo (Nasdaq: YHOO)                    -33% (Nasdaq: AMZN)               -12%
Internet Capital Group (Nasdaq: ICGE)   -58%
CMGi (Nasdaq: CMGI)                     -47%
Qualcomm (Nasdaq: QCOM)                 -17%
Commerce One (Nasdaq: CMRC)             -36%
VerticalNet (Nasdaq: VERT)              -50%
eBay (Nasdaq: EBAY)                      35%
Echelon (Nasdaq: ELON)                  325%
JDS Uniphase (Nasdaq: JDSU)              48%
Some of these returns should make those who "missed the run on tech" late last year feel vindicated. But not so fast. These numbers, in most cases, do not go very far in erasing the huge gains these companies have enjoyed. Plus, any three month period, unless something really dramatic has happened, such as the AOL/Time Warner merger, is not a sufficient period of time to evaluate share performance. That is, unless you're a day trader or a speculator, in which case, best of luck to you.

Fiat, Fool!

Bill Mann, TMFOtter on the Fool Message Boards