It's Not Different This Time

Every once in a while, an invention comes around that really does change the world. Think of Thomas Edison's light bulb, Henry Ford's mass-produced automobile, Elisha Otis' safety elevator, and Willis Carrier's air conditioner. Every last one of these inventions is absolutely critical to our modern lives. Without them, our cities would be dramatically different, our suburbs would be mostly nonexistent, and many of the jobs we do and lives we lead simply would not be possible.

Looking at the companies that were either launched to stardom by, or eventually acquired the rights to, those once world-changing inventions, however, tells us a far more mundane story.

These companies' effect on the modern world is both gigantic and indisputable. Yet right now, their stock market valuations reflect virtually no excitement whatsoever.

Good things do end
Keep those titans in mind while fast-forwarding to the late 1990s. At that point, the Internet was the next generation of world-changing technology. Since everything was digital and virtual on the Internet, the theory was that companies really could grow to the sky. After all, in the digital era, there were literally no physical constraints holding them back. "It's different this time" was the battle cry of dot-com mania.

That battle cry launched companies' stocks to unbelievably high valuations. Much of the high-tech industry traded at prices far beyond what was justified by the cash they were generating, or were even likely to generate in the legitimately foreseeable future. With investors actually believing that there was no limit on growth, some companies' stocks traded as though they'd double in size every year, essentially forever.

Those were some mighty high expectations. Unfortunately, if taken to their logical extremes, it would have implied growth so large that they overwhelmed the entire world's economy. Absurd, isn't it? Yet very real people were making very real investments based on those presumptions of unstoppable growth.

Unfortunately, we all know how that turned out. Here are three of the surviving companies from that time, in fact, and where they trade now, nearly seven years later:

These were some of the best-positioned technology companies in the 1990s. Yet they now trade as mere shells of their former selves. If it did nothing else productive, the high-tech boom and bust reminded us of the lessons taught by those that came before us -- the previous generation of world-changers. The cold, hard reality is that, in the end, the value created by a business matters most to investors. All the technological wizardry in the world matters not one bit if the company can't generate enough cash for investors to justify the price of purchasing its shares.

Will the market ever learn?
Time and time again, companies that look like they're changing the world eventually end up facing reality. No company grows to the sky, no matter how in-demand its products may be. At some point, either the market becomes saturated and growth grinds to a halt, or the company's prices rise so high that alternatives become economically feasible.

These days, for instance, the current big thing is fuel ethanol. High oil prices, Middle East instability, and Congressional meddling have caused a huge upswing in the demand for and price of ethanol. That's triggered heavy speculation in companies like Pacific Ethanol (NASDAQ:PEIX). While its shares are off their peak levels from earlier this year, the company is still trading at about four times its trailing revenue, and nearly 44 times its anticipated profits for 2007.

That's absurd. Fuel is a commodity business. How much (if any) profit the company will make in 2007 is heavily dependent on what the price of ethanol is that year. If this chart is any guide, that number is anybody's guess. Along the same lines, Pacific Ethanol couldn't make a net profit with the tremendous spike in the price of its primary product in May and June 2006. What chance does it really have of profiting at all if the price of ethanol reverts anywhere near its historical levels?

Yes, those radically optimistic predictions could come true; stranger things have happened. Ask yourself, though: Is that really the kind of risk you want to take with your money?

Invest smarter
If you try to invest in the next big thing, if you're lucky, you'll wind up with the next Ford. If you're not so lucky, you could very well wait for quite a long time for the growth to materialize to justify an overvalued purchase price.

Fortunately, there is a better way to invest. Instead of looking for the next big thing and counting on potential growth to justify your purchase price, you can look for companies throwing off prodigious amounts of cash today. It's a strategy known as value investing, and it's precisely what we follow at Motley Fool Inside Value.

In the end, after all, what really matters is how much money an investor gets back from an investment. Cash is cash, regardless of what company earned it. Simply put, money a company will generate now and in the near future is worth far more than money a company may generate at some time in the future. That's why, in spite of their now-boring stories and ho-hum growth prospects, value-focused investments so routinely trounce the market.

It's also why our Inside Value performance numbers have been so solid, besting the S&P 500 since our inception a bit more than two years ago. By basing our decisions on the realistic near-term cash-generating potential of the business, we simply have that much better a chance of seeing our projections come true. Cash flow is still king -- that's why our brand of value investing does so well. If you're tired of losing your money by investing in growth stories that almost never work out for shareholders, join us at Inside Value. With an option to take a 30-day free trial by clicking here, you really have nothing to lose but your time.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of GE. The Fool has a disclosure policy.