Motley Fool Staff
Jan 26, 2000 at 12:00AM
The fact that eBay continues to dominate the online auction space, in spite of aggressive competition from the likes of Yahoo!, Amazon, and others, is all the more impressive. Add to that the fact that management indicated that it expects to remain profitable throughout the year (and presumably beyond) and voila! the stock rises.
The big bugaboo that is generally bandied about in the mainstream press in regard to Internet companies is: How can these companies possibly deserve such high valuations when they're not profitable? It isn't just in the press that one hears this. One hears it as well from intelligent people on the tennis court, in the supermarket, in investment clubs, and ski lodges and car repair waiting rooms -- yes, if one happens to be wearing a Motley Fool sweatshirt, the darndest conversations seem to come out of nowhere.
It's certainly a fair question. A company must eventually be profitable. Money is, in this regard, the lifeblood that the company-organism needs to survive. If you're constantly hemorrhaging your lifeblood, you begin to look pale and wan, your lips turn blue, you're weak, and you're not long for this world. To avoid this decline, you better make sure that you have ample sources for transfusions. A company might use its high market valuation to acquire other companies in a delicate operation toward achieving eventual profitability, or it may enter attractive, new business lines toward the same ends.
However, the "where are the profits right now?" questions miss what might be called the longer-term view, or the big picture. Since we Fools are big on the longer-term view, let's make an analogy here.
Say your seven-year-old has a lemonade stand. She finds a nice street corner on a hot summer's day and, seated beneath her blue parasol, takes in $5. The next day, all excited and flush with her booty, she decides to put up a sign on the corner. Lo and behold, sales double! She makes $10. Before long, bit by the entrepreneurial bug, she enlists the aid of her kid sister to open a second stand across the street. (This all takes place, of course, under your watchful eye.)
When this expansion works out well -- and after the sibling flare-ups have simmered down as to who gets how much of the candy money -- she gets a few of her friends involved. Stands begin to pop up all around her neighborhood. Now she's making $100 a week; then $200, and before you know it she has "earned income" and can qualify for her very own IRA.
But wait. Her costs are increasing. After all, she needs to pay for the lemonade and the sugar, not to mention the way-below-minimum-wage she's paying you, her parent, to build her stands. What she's doing is taking all her money and investing it into the business. More stands! More signs! Bigger signs! More employees! The sky's the limit! In fact, she hires a skywriting plane to write big in the sky -- and she gets news coverage from her Uncle Mervin who's the traffic guy on Channel 4.
Her sales are growing mightily, and she's plowing money right back into building her business, but her profits may have gone out the window. This is, in essence, why Internet companies are permitted high valuations even though they do not yet show profits: the business and the customer base are growing, and growing fast.
In contrast to your daughter's lemonade stand, they also have some huge advantages over their bricks-and-mortar counterparts. Here in France, for instance, I find myself ordering books from Amazon.com (Nasdaq: AMZN) on a fairly regular basis. I'm not in a big rush for them, so shipping isn't very expensive (it tends to be around $5). How or when else would I be able to get just about any English language book I might desire delivered to my door? In other words, the technology and service delivered by the Internet has permitted sales opportunities to the company (and others) that just had not existed before.
This is why sales (as opposed to profits) are so important for Internet companies, and are given more credence when valuing such companies. In a recent Jupiter Communications survey, retail consumers spent $7 billion dollars shopping online during the recent holiday season, and 90% of them reported that they were satisfied with their shopping experience. Only 4% said that they would likely decrease online spending in 2000; 35% said that they were encouraged to buy more than they had previously anticipated.
This, in a nutshell, is what a growing market is all about. A rapidly expanding customer base, a technology that allows never-before-possible customer profiling and product suggestion and cross-promotion, along with automated order tracking, rapid delivery, and a high level of customer service -- these are all powerful features. (Gift-challenged individuals, such as I, really do welcome the crutch of suggestions offered by these sites.) Of course, it then makes sense for the company to spend money on marketing, on making sure that the customer has a great experience, on acquiring other companies whose products they want to sell, or whose technology aids them in fulfilling their mission.
As we investors peer into the future, attempting to predict just how successful these companies might become and what they might be worth, these are some of the things we look at: sales growth, reinvestment in the business, ongoing expansion and more. If we feel the outlook is bright, we invest.
In companies like eBay and Amazon, we feel that the future is bright indeed.
Amazon today was down $4 1/8 to $64 13/16, possibly in response to news stories that buy.com will soon be going public. Or possibly for some other short-term reason.
Go figure. But figure long-term.
Motley Fool Staff
- Jan 26, 2000 at 12:00AM
- Special Announcement: The Motley Fool Unveils Ultimate “Organic Intelligence” Breakthrough
- What Is "Financial Wellness," and What Does a Lack of It Mean?
- The Psychology of a Rule Breaker in Good Markets and Bad
- Rule Breaker Psychology: When Markets Dip, Remember This
- Fixed Income Is Boring, But Safe.