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company called PayPal, which makes it easy to make purchases and
transfer money online, went public on Feb. 15 and jumped 55% the
first day. The press, predictably, greeted this success with snickers.
Typical was a report on SmartMoney.com: "Take one profitless
dot-com. Add a patent-infringement lawsuit and clashes with regulators
in four states. What do you get? A rip-roaring IPO." Wrote
the New York Times: "Sounds like 1999? It happened today."
But not so
fast. PayPal is a real business, with 12.6 million registered customers
and a huge following among users of eBay, the online auctioneer.
Don't get me wrong. I am not telling you to rush out to buy the
stock. For one thing, eBay is beefing up its own PayPal-like competitor,
Billpoint. But, while it's smart to be skeptical of any newcomer,
it's foolish to write off a company just because it's a high-technology
fledgling.
That's one
of the key lessons of a fascinating new study by Michael Moe, a
former Merrill Lynch & Co. education-stock analyst who now runs
ThinkEquity, a boutique investment firm in San Francisco. Like all
the best research, Moe's was elegantly simple. He compiled a list
of the 20 stocks whose share prices increased the most for the 10
years ended Dec. 31, 2001.
Fourteen of
the 20 companies were in high technology, nearly all of them benefiting
from the Internet boom. No. 1 on the list was Dell Computer Corp.,
whose sales have increased from less than $1 billion to more than
$30 billion in a decade, in large part because of the firm's agility
in selling online — plus the demand of consumers and businesses
for products that link to the Internet. No. 2 Emulex makes sophisticated
connectors that speed the storage of electronic data. No. 8 Cisco
Systems Inc. is the prime manufacturer of Internet infrastructure.
Other well-known tech names on the list include EMC Corp. (4), Applied
Materials Inc. (5), Oracle Corp. (6), and Maxim Integrated Products
(10). The performance of the 20 stocks was astronomical. Dell's
stock price, for example, increased by 7,890%. In other words, an
investment of $1,000 grew to $79,900 in 10 years. Even the No. 19
stock, Intel Corp., rose 1,668% — not including dividends,
which alone rose by a factor of 10.
Speaking of
10. . . . In his 1989 book, One Up on Wall Street, Peter
Lynch referred to his quest for "tenbaggers" — stocks
on which he might make 10 times his money. He cites many he missed,
including Deluxe Check Printers, insurer Geico (now a private component
of Warren Buffett's Berkshire Hathaway Inc.) and C.R. Bard Inc.,
a maker of medical devices. "In my business," Lynch wrote,
"a fourbagger is nice, but a tenbagger is the fiscal equivalent
of two home runs and a double." Intelligent investing is a
quest not for companies that will be 50% gainers in one year, but
for companies that will be tenbaggers in 10 years. For example,
Analog Devices Inc., a chipmaker that finished 15th in Moe's survey,
was a 24-bagger over the past decade even though its price dropped
by more than half from mid-2000 to the end of 2001.
Of course,
only a handful of stocks will be 24-baggers, but all you need is
one. How do you find such humongous winners? Not simply by scouring
balance sheets, cash flows, and income statements — after all,
many of these firms don't have much history to examine. Instead,
look also for great business ideas, wonderful market niches with
little competition, and good managers with lots of integrity. In
other words, to get giant returns, you need to think like a venture
capitalist.
And that's
really the story of high technology in the 1990s. Many companies
came to market in a "pre-IPO stage." In other words, they
were not ready for prime time, lacking the traditional qualifications
for an initial public offering. They were companies that, in the
past, would have been financed by friends and relatives of the entrepreneurs
who started them and by deep-pocketed venture capital firms. But
the Nasdaq was gracious enough to allow early-stage companies with
little or no profits to list shares. The result was that many of
these firms went broke, or close to it (TheStreet.com, for instance,
dropped from $60 on its opening day less than three years ago to
$1.78 on Friday), but a few became 24-baggers, and more.
Over the past few years, ridiculing high-tech companies has become
a popular sport. A new book, Dot.con, by John Cassidy, economics
writer for the New Yorker, argues that Internet stocks were
empty shells, puffed up with hot air by stock analysts and other
Wall Street and Silicon Valley sleazeballs (they were helped, too,
he says, because even Alan Greenspan, the Fed chairman, was seduced
by the tech scam). This is nonsense. Stock promotion did not begin
with tech shares, nor will it end with them. Ultimately, stock prices
depend on the real-life success of companies themselves. The problem
(if you can call it that) with tech was that the companies, being
relatively young, were extremely risky. The ratio of losers to winners
was high, but the gains of the winners — for investors with
perspicacity and patience — more than made up for the losses
of the losers.
Imagine, for
instance, that 10 years ago you had bought a portfolio of 20 technology
stocks, investing $1,000 in each. Nineteen of them go broke —
straight to zero — but one of them is EMC Corp. You buy 80
shares at $12.50 each. The stock undergoes six splits, and at the
end of 2001 you own 3,840 shares at $13.44 each. So your $20,000
portfolio has grown in value to more than $52,000. Is 10 years too
long to wait? EBay Inc. was launched in 1996 and issued shares to
the public on Sept. 28, 1998. The stock closed that day at $47.
Say you bought 100 shares for $4,700. The value of those shares
now stands at about $33,000.
In research
for his forthcoming book, Bubbleology: The New Science of Stock
Market Winners and Losers, Kevin Hassett, my colleague at the
American Enterprise Institute, constructed an index of publicly
held Internet-related stocks. Between January 1999 and May 2001,
a period that included the huge collapse of tech shares that began
in spring 2000, the index rose more than 40%. But, again, the number
of losers overwhelmed the number of winners, and half the stocks
lost more than 50% of their value. That's the nature of these companies.
But back to
Michael Moe's list. Why did the stocks rise? Mainly for the most
old-fashioned of reasons: Their profits rose. The average annual
increase in earnings per share for the 20 companies was 34%; the
average annual increase in stock price was 41%. Again, this is just
what you would expect. TheStreet.com's stock has collapsed because
the company has never made money, but Oracle stock has risen an
average of 43% a year because its earnings have risen an average
of 42% a year. To find stocks that will grow in price, find stocks
that will grow in earnings.
But what do
these huge winners tell us about price-to-earnings (P/E) ratios?
"What's interesting," writes Moe in a letter to his clients,
"is that the average P/E of the top 20 was almost 30 at the
beginning of the 10-year period." In fact, six of the companies
had P/Es in 1991 that were over 40. A reasonable conclusion is that
a high P/E is no reason to eliminate a stock. By the way, average
P/Es rose to 48 by 2001, an indication that investors still think
these firms will do well in the years ahead.
Another important
fact gleaned from the list, however, is that only three of the 20
were unprofitable in 1991. You don't necessarily have to pick future
tenbaggers from among companies with a history of losses. In fact,
one of my rules is never to buy stock in a firm that hasn't made
money. You can wait and still make a bundle. In 1991, for example,
Cisco, at age 7, was earning $43 million on $187 million in sales.
It became a 36-bagger in the next 10 years. And don't forget that
non-techs can be monster winners, too. On Moe's top-20 list were
Clear Channel Communications (a 54-bagger), radio; Best Buy Co.
(36-bagger), retail chain; Robert Half International Inc. (25-bagger),
personnel; Harley-Davidson Inc. (19-bagger), motorcycles; and Jeffries
Group Inc. (38-bagger) and Eaton Vance Corp. (19-bagger), finance.
Still, in general,
tech is where the action was in the past decade and where it will
probably be in the decade ahead. Just remember that the action is
wild. Go ahead and search for a few big winners, but protect yourself
through diversification — own lots of tech stocks, but keep
only about one-fifth of your total stock assets in tech. Don't go
overboard on tech, but don't neglect it, either.
Among the stocks
mentioned in this article, James K. Glassman owns Dell Computer.
His new book is "The Secret Code of the Superior Investor,"
and he can be reached at jglassman@aei.org.
—
Among the companies named, Mr. Glassman owns Dell Computer. His
new book is The
Secret Code of the Superior Investor. This column originally
appeared in the Washington Post.
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