USA TODAY: More Commentary on Internet Stocks

USA TODAY: More Commentary on Internet Stocks

By Sandra Block

Section: MONEY
Page 3B

If you’ve ever been stuck on an Amtrak train that has run out of sandwiches, you may have difficulty imagining a time when railways were heralded as an innovation that would forever change the way we live. But in 1845, a British journalist declared that railways would herald ”the arrival of a time when the whole world will become one great family, speaking one language, governed in unity by like laws and adoring one God.”

That was more than a century before e-mail, but the mania that accompanied the development of the railroad bears a remarkable resemblance to the modern ballyhoo over Internet stocks. Thousands of investors sank money into railroads, convinced they couldn’t lose, according to Devil Take the Hindmost, a new book by Edward Chancellor that chronicles the history of financial speculation.

By 1850, however, the railway industry was plagued by overbuilding, competition and rising costs. Shares fell 85% from their peak. The automobile appeared. Many railways went out of business, and investors were wiped out.

Chancellor’s meticulous research offers some valuable lessons for investors who are tempted to wade into the Internet pool. True, Internet stocks are considerably less expensive than they were three months ago, with some stocks off as much as 50% since their peak on April 22. But just because these stocks have dropped in price doesn’t mean they’re a bargain. And like the early railways, they’re anything but safe.

Many well-known Internet stocks — those that have earnings — are still trading at enormous price-earnings ratios, that is, the share price divided by earnings per share. And most start-up Internet companies have yet to make a profit. Still, just a few months ago, fans of Internet stocks defended their lofty prices, arguing they represented the companies’ tremendous potential.

Recent events suggest investors are starting to doubt those cheery forecasts, says David Yeske, a financial planner in San Francisco. For the first time since the Internet boom began, interest rates are rising and are almost certain to move higher. (Story, 1B.) Rising interest rates threaten to slow the growth of nascent companies by increasing borrowing costs.

”Investors are beginning to treat Internet stocks a little more like every other kind of stock,” Yeske says. ”If that shift continues, there’s a lot more downside to come.”

Undoubtedly, a few existing Internet companies will outlast the inevitable shakeout. But even if you’re convinced you’ve found the winners, don’t bet the farm.

”I wouldn’t put any money in these stocks that I couldn’t afford to lose,” says David Kathman, a stock analyst for Morningstar. ”I would consider buying these stocks basically a form of gambling, with the odds just a little better than the slot machines.”

If picking winners were easy, every investor and fund manager with a handful of cash would have invested in Microsoft 10 years ago. But then, many investors thought Microsoft was incredibly overpriced and stayed away, Kathman says. Since August 1989, Microsoft’s stock has split seven times and risen more than 10,000%. ”In retrospect, it was a bargain,” Kathman says.

Internet funds

Of course, you could entrust your money to an Internet mutual fund, in hopes the fund’s manager will have better luck picking winners than you. But Kathman is skeptical of that approach. As the chart shows, the Internet funds have fallen at about the same rate since mid-July. ”I don’t know if any of those Internet funds is better than any of the others at picking winners,” he says. ”I kind of doubt it.”

Investing in Internet funds carries another risk. If the sector continues to slide, and the funds’ returns suffer, that could prompt investors to redeem their shares. If enough investors bail, fund managers will have to sell some of their stocks to raise cash. Not only would that hurt the funds’ returns, it could also create taxable capital gains distributions. Come December, you could find yourself stuck with a fund that hasn’t gone anywhere — and a big tax bill.

Managing Your Money appears Tuesdays and Fridays.

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Net performance

Performance of Internet funds since mid-July:

 Total return{+1}
Fund                             July 15-Aug. 5              1999
 Internet Fund                        -20.8%                  69.3%
Monument Internet Fund               -20.4%                  67.7%
Munder NetNet                        -19.2%                  33.7%
WWW Internet Fund                    -15.5%                  25.0%

Source: Lipper. 1 – Dividends and gains reinvested through Aug. 5