Last week, we ran a column on the demise of Pets.com (Nasdaq: IPET) that endeavored to answer why and how this company, and so many like it, went public only to die within a matter of months. Usually, companies wait until they have a viable business before selling shares to the public. In fact, being viable is a prerequisite. Usually.
During exciting booms in new technologies, human nature gets the better of most of us, and many of the usual rules are thrown out the window. That is how capitalism quickly spurs on promising technologies.
It happened before, it'll happen again
When automobiles started to become mainstream, more than 200 automobile manufacturers appeared and went public. Most vanished. Years before that, hundreds of railroad-related companies, from train builders to track layers, went public in an equally exciting boom. Most vanished. Even the invention of radio unleashed hundreds of new related companies on the stock market, and -- you know it -- most vanished.
The same is happening with the Internet. Many of the new companies will vanish. In fact, perhaps more than usual will vanish because, of all the past technologies just named, the Internet is the most accessible to the public. Just try to start building a train in your home office. In contrast, it is simple to buy a website address, some programming books, and set up an online business. Thus, thousands of people did, and several hundred questionable companies quickly went public. Most won't last.
Our column last week asked why and how all this happened. The answer is that a confluence of events happened in the past few years just as it has happened in other decades long ago. When an exciting business opportunity arises, people across the spectrum become excited (from the entrepreneurs, to venture capitalists, to already existing companies, to stock underwriters, and down to investors). Amongst all the excitement, money starts to flow while thousands of entrepreneurs give things a try. Hundreds might quickly become public.
Meltdowns are part of the system
After our "Why Pets.com Died" column last week, David wrote about the dot-com sell-off to remind investors that it was investors -- you and me -- who were largely responsible for the run-up and subsequent crash in prices of the dot-com stocks. It was also, as David wrote, the many businesses that invested funds that helped fuel the fire. For example, Amazon.com (Nasdaq: AMZN) invested in several failed dot-com ventures, and even Starbucks (Nasdaq: SBUX) got drawn in by the excitement.
There isn't anything wrong with this, however! It was the most natural thing to do at the time: If a company sees a new opportunity that looks appealing, and the time seems ripe, it should invest. If it does, it obviously doesn't expect failure.
I'll now supplement David's thoughts from last week. As he'd agree, it wasn't just the public investors and the businesses like Amazon that caused the rise and fall of these stocks. Mutual fund managers, stock analysts, stock underwriters, and venture capitalists played at least an equal, if not larger, role in the rise and fall of most of the stocks -- and, to be fair, in the success of several others, too.
From the start, venture capitalists first agreed to fund half-baked ideas. They were the first line of "demand." Underwriters agreed to take those ideas public. Stock analysts (most not related to a company's underwriters!) put out aggressive recommendations on many eventual meltdowns, from priceline.com (Nasdaq: PCLN) to drkoop.com (Nasdaq: KOOP). Mutual funds piled in, moving prices much more than individual investors could. Finally, stock brokers pushed these stocks onto the public, who largely bought.
You know what? Everyone was doing what has been done during any new technology boom: They were conducting a lot of business, quickly, excitedly, and not always rationally -- as a "buy" rating on eToys (Nasdaq: ETYS) at $4 billion from the largest names in the analyst business proves. The fact is, during sweeping times of change, most people get swept up. Why? Because they're alive! They get excited. Plus, there is true opportunity to be found floating among the dozens of half-baked ideas. That fact adds to the melee.
Learning from the past
Overall, there isn't any point in pinning blame on anyone in particular for the rise and fall of "Internet stocks." This rise and fall was as natural as the sweep of an ocean wave. When promising technologies emerge, we will always see a rush of venture capital investments, which leads to a rush of Initial public offerings (IPOs), which leads to investor excitement and rising prices.
Soon, regardless of what public investors buy or don't buy, most of the new speculative businesses will disappear or languish without enough sales or money. A small handful will dominate and thrive. That's the system. If we wanted to blame anything for the Internet sell-off, we'd need to blame our entire free system of business, a system that continues to fund many great businesses.
So, the most we can ask of the past is to learn from it.
Investors should realize that, with every new boom (including business-to-business e-commerce, wireless, fiber optics, and biotech), there is going to be a rush of capital invested and a rush of stock offerings. During these times, some companies will soar from the beginning and keep going -- but very few. Many companies will soar at the beginning and soon fade. Remember this the next time that any young sector captures Wall Street's imagination and is rushing to the public market. Use the Rule Breaker principles and criteria to help you find the very best companies, and then avoid all the rest.
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