Internet Investing
Wednesday, May 13, 1998
by Jeff Fischer

ALEXANDRIA, VA (May 13, 1998) -- There are an estimated 40 million Americans using the Internet, or about 20% of the population. This number is expected to grow well over 30% annually over the next three years (beginning in 1999), following a 40% jump this year. In 2001, it's estimated that over 100 million Americans will use the Internet. Meanwhile, e-commerce volume is expected to grow more than 100% annually into the year 2001.

These growth numbers are merely estimates -- they're anyone's guess. E-commerce is growing more quickly than was anticipated, though, which makes the rush for mind share (and market share) even more vital right now for Internet companies. That means spending money, and that means operating losses.

So when you consider how young the commercial Internet is, and how young all Internet companies are (while admitting to yourself that it takes time to turn any company profitable), it remains intriguing that the bears' main argument against most Internet companies usually boils down to this illogical whine:

"They're not making any money!"

Well, duh. Of course not. This is a new industry, with new companies -- companies that are only beginning to build their businesses. Beyond those facts, the majority of start-up companies in the world, public or private, are not profitable for a number of years anyway, often at least five. If you want to really talk statistics, most companies never turn a profit and thus go belly up; so the Internet (already showing signs of profitability for the right business models) arguably offers more promise for success than would beginning a traditional, non-Internet business.

Even so, the aim right now is not for profits. In the past two weeks I've read, literally, half a dozen articles on (Nasdaq: AMZN) that discuss the stock's valuation, mention the many good things that Amazon does, but then slam it as a potential investment because the company has yet to make a profit.

Has yet to make profit?

Amazon has been public for one year (one year on May 15, to be exact), and the idea behind going public was to raise money so that it could spend it -- not horde it, spend nothing more, and then quickly be profitable. Amazon could have been profitable last year if it hadn't spent any discretionary money. It probably would have had 1/10th of the revenues, though, and it would have sacrificed its future. Instead, luckily, the company spent aggressively and has built a sizable lead over the competition.

Amazon (and other Internet firms) will continue to spend heavily until the benefits gained by spending diminish substantially -- which will happen several years from now, when a majority of Internet users already have habits that won't easily be changed by marketing initiatives. Now is when habits are being formed, though, and you have to spend money to shape habits.

So bears: dispense with the "no profit" argument for now. It's downright lame. If more leading Internet companies aren't making a profit in three to five years, then the Internet economy as a whole will have proven to be much more challenging than anyone thought, and then the bears will have a valid argument to stand on. But until "then" happens, bears need to find a different argument, because none of these companies are even trying to make a profit. They're trying to spend enough money so that they have a future -- just as this country's government spent more on its infrastructure, as a percentage of income, during the Great Depression than during most all other time periods. FDR knew that you needed to spend in order to have a future at all.

In the meantime, when thinking of these stocks' valuations, a quote from The Industry Standard magazine states:

"If I taught a class, I would ask, 'How much is this [Internet] company worth?' Anyone who would answer, I would flunk."

This interesting remark is from Warren Buffett. From this comment one can surmise that he doesn't take the Internet bears and their doomsday price predictions any more seriously than we do -- because no one knows for certain. As with any industry, though, leaders will continue to emerge while hundreds of second-tier companies are likely to struggle. So rather than look for immediate profits at these companies, a potential Internet investor should look for the absolute leaders now -- those with the best management and the potential to win the long-term market share. As for bears, short the third and fourth tier Internet players if you want to short any of these companies, because we've all seen what shorting the leaders like America Online, Yahoo!, and Amazon has amounted to so far:

Nothing but "Ouch."

And this might be just the beginning of the long-term pain.

Portfolio Summary. The Fool Port topped the market on strength in its Internet companies, but 3Com (Nasdaq: COMS) continued to struggle despite an upgrade from Everen Securities. Fears exist that the company has more undisclosed bad news to share in its coming quarterly announcement, due during the third week of June. Currently, $0.18 per share in earnings is expected. Some argue that there can't be any more bad news -- that the company has already shared all of it. Whatever happens, fiscal 1998 has been a drag. The stock trades at 49 times earnings estimates for the year ending this month. It trades at 20 times the guess for next year's earnings.

Innovex (Nasdaq: INVX) has continued to drift since announcing earnings in April, despite the conference call admission that things were finally improving. The stock trades at 14.5 times earnings estimates for the year ending in September, and at 9.8 times next year's estimate.

Finally, yesterday I stated that, "there are 7,300 days in 20 years. Of those days, there are only 5,200 market days. That's only 33,800 market hours. That's only 1.21 billion seconds."

An employee of Intel (Nasdaq: INTC) wrote to correct me. There are actually only 121 million seconds in 33,800 hours. So, twenty years of market time is only 121 million seconds. This is all the more reason that a Fool should be able to look beyond the short term and focus on the 20-year long term when investing. Thanks to the Intel employee for the correction! There must have been a mathematical "bug" involved in my computation.

Fool on!

--Jeff Fischer

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Stock Change Bid ---------------- AMZN +1 3/4 92.88 AOL +2 1/4 90.00 T + 1/4 58.00 DD +1 7/8 81.88 DJT - 1/8 8.69 XON - 3/16 73.63 INVX - 9/16 23.38 IP --- 54.25 IOM - 1/16 7.50 KLAC - 3/8 41.00 LU - 13/16 72.25 COMS - 1/2 30.38 TDFX + 3/8 23.50 SPY + 5/32 112.09
Day Month Year History FOOL +1.09% 3.41% 25.69% 321.82% S&P: +0.27% 0.64% 15.30% 144.08% NASDAQ: +0.32% -0.12% 18.84% 159.13% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 90.00 2374.95% 5/17/95 1960 Iomega Cor 1.28 7.50 485.75% 10/1/96 84 LucentTech 23.81 72.25 203.47% 9/9/97 290 38.22 92.88 142.99% 8/12/96 130 AT&T 39.58 58.00 46.55% 2/20/98 215 DuPont 59.83 81.88 36.84% 1/8/98 115 S&P Depos. 95.91 112.09 16.88% 2/20/98 200 Exxon 64.09 73.63 14.88% 2/20/98 270 Int'l Pape 47.69 54.25 13.75% 4/30/97 -1170*Trump* 8.47 8.69 -2.58% 8/24/95 130 KLA-Tencor 44.71 41.00 -8.30% 1/8/98 425 3Dfx 25.67 23.50 -8.44% 6/26/97 325 Innovex 27.71 23.38 -15.64% 8/13/96 250 3Com Corp. 46.86 30.38 -35.18% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 63900.00 $61318.13 9/9/97 290 11084.24 26933.75 $15849.51 5/17/95 1960 Iomega Cor 2509.60 14700.00 $12190.40 2/20/98 215 DuPont 12864.25 17603.13 $4738.88 10/1/96 84 LucentTech 1999.88 6069.00 $4069.12 8/12/96 130 AT&T 5145.11 7540.00 $2394.89 2/20/98 200 Exxon 12818.00 14725.00 $1907.00 1/8/98 115 S&P Depos. 11029.25 12890.78 $1861.53 2/20/98 270 Int'l Pape 12876.75 14647.50 $1770.75 4/30/97 -1170*Trump* -9908.50 -10164.38 -$255.88 8/24/95 130 KLA-Tencor 5812.49 5330.00 -$482.49 1/8/98 425 3Dfx 10908.63 9987.50 -$921.13 6/26/97 325 Innovex 9005.62 7596.88 -$1408.75 8/13/96 250 3Com Corp. 11715.99 7593.75 -$4122.24 CASH $11558.06 TOTAL $210910.97

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