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April 26, 2000

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Subject:  Communication and the New Economy
Author:  teacherjh

Lately (and actually, not so lately) I've been reading about this "new economy" and how the rules of investing have changed - that profits no longer matter and that "old economy" companies are no longer the ones to own. Then, in a move that seems to surprise everyone, all of a sudden the "old economy" is being revived. How'd that happen? How'd it slip by?

Well, there never was a "new economy". This was just a journalistic gimmick to get you to buy more newspapers and magazines (and read more ads). What is widely touted as the new economy is just the old economy, deferred, as expectations are raised that the deferral won't be for too long.

There has been a general trend (since the beginning of the century in 1901) for change to happen more rapidly than before. It is tempting to say that this is because information is gaining precedence over goods, but in reality it is because better communication makes larger changes more possible faster. As the idea transmission mechanism moves from the pony express to the railroads to the telephone to the television, new ideas can be transmitted and become adopted closer to the speed of saying "that's a good idea" nationwide, than to the speed of saying "that's not how grandma used to do it" household by household. Fast and deep communication also allows corporations to become much bigger and more influential faster, and allows them to react faster internally to conditions.

It's a no brainer to realize that if change is happening fast, the future will look more different from the present than if change were slower. This implies, of course, that the present becomes less useful in predicting the future. And the whole point of investing is to benefit from the future. (otherwise, you'd just spend your money rather than invest it!)

What is desired by an ultimate investor is the dividend stream - the profits from the company's business flowing to the business owner (stockholder). Some people will come late to the game, some will exit early, and each will take (or lose) some portion of the difference between the present stock price, and the value of the ultimate dividend stream. The liquidity of the stock market allows people to jump in and out at will, and benefit from both short term and long term volatility. Benefiting solely from such volatility (selling at a peak to buy back at a dip) is thus a zero sum game. You could even think of it as "long term day trading". It could make you a lot of money when faced with the likes of IOM and ATHM, but in a sense is gambling, inasmuch as it does not depend on the ultimate dividend stream, whose benefit will not be reaped by any who exit early. When this effect is explicitly subtracted out, what is left is what one would have if one simply bought in at the start, and held forever. This is the value of the business. The rest is noise.

In between IPO and dividends, the business grows (or fails) through management and external actions, with no direct benefit to the stockholder. As the business gains more visibility and success, it attracts the attention of others who covet the (imagined) future dividend stream and want in, causing the stock price to go up.

Most investors pick stocks because they think they will go up. They can then sell them for a capital gain and buy other stocks that will go up. It's the rare investor who gets in early and holds through dividends. But imagine if that's all you could do. Imagine if you (but not everyone else) could never sell a stock. You could only buy the stock, and get income from the dividend stream when (and if) it materializes. Imagine you're also young enough to enjoy such a stream. Now pick your stocks.

Is AOL one of them? Is Microsoft? Is General Motors? How about Levity Inc., which recently discovered and patented a rudimentary anti-gravity system has come to your attention, do you buy in? How do you decide?

All of a sudden you can't count on the rush of excitement to give you a chance to unload your shares at a fabulous gain, and you can't count on a steady stream of good business to keep boosting the share price, because you can't sell into it. You have to wait for profits, and then enough profits to pay dividends. Will that ever happen?

Gee, that sounds very "old economy, doesn't it! Well, the last one holding the stock gets that, and the intermediate prices of the stock reflect the likelihood of the revenue stream materializing and being lucrative. No matter how it's sliced, profits eventually matter.

My personal belief is that AOL will not only become a cash cow, it will become a cash volcano, spewing out so much in dividends we won't even know how to spend them. It leads the (continuing) communication evolution, and (as goods go digital) it also leads in the delivery evolution. This is why I hold the stock, despite the fact that sometimes people don't really believe it will happen (and the stock price goes down) and sometimes people really see the future (and the stock price goes up). None of that matters, as long as the business and its environment keep moving in that direction. AOL aggressively and successfully pursues other revenue streams while still getting people to pay monthly for the privilege of signing on. Those other revenue streams are starting to gain momentum, and spawn other streams themselves. Every "new economy" company will either embrace or be embraced by the old economy rules, just like every flying machine is subject to the laws of physics. AOL knows this - it always did.

A fine wine (or even a profitable jug wine) begins with an empty field, upon which grape vines are planted. It takes five years or more before grape vines start to become productive, and even longer for the grapes to be any good. After that, they have to be mashed and fermented, and the result at this stage can still be pretty harsh. But properly aged, the tannins and the tears and the nose all blend in, and under the direction of a fine vintner will produce a wine which, quaffed perhaps with a rare venison or roast duck, will transport the imbiber to a new dimension of sensory pleasure.

Few people see this in a handful of dirt and grape seeds. And although AOL is past that stage now, (and it can be argued that it is a profitable jug wine rather than a fine Bordeaux) the vines still have a few years to go before harvest.

But I have my ticket. When the wine is ready, I'll be at the table!


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