Robert Doucette: “I am continually amazed by the Internet companies, whose valuations seem to have no connection with reality, and whose stock prices CAN’T get any higher, but do. Yes, we know that the stocks seem to be grossly ovepriced. (The only stocks going up these days are those that were already too high.) Yes, we know this can’t continue forever. (These are not stocks for widows or orphans or Warren Buffett.) But, how risky is an investment in these companies today? Are there any rules of thumb to guide investors about a hot market that gets cold (and goes south)? For example, when the Nifty Fifty cooled in the early seventies, how fast was their fall?”

Well, Avon was close to 140 in mid-1973 and under 20 by the Fall of 1974 (and what a Fall it was).

Disney dropped from 210 at the end of 1972 to 31 less than two years later.

And so on.

The fall wasn’t fast in the sense of its taking just a week or two. That sort of thing happens when there’s bad news — as in 1997, when Oxford Health dropped from around 70 to 25 or so in three days. (It would later dip below 6.)

But these companies were basically doing fine. No, as sharp as the decline appears on the charts now, the fall was slow-motion torture when you actually lived through it. And it must have been particularly galling to the owners of the Nifty 50 — I shunned those for a few of the Thrifty 5000, which fell even further — because, I say again, for the most part their businesses were fine. It’s just their stock price multiples that were deflating. Where once they had been selling at 60 times earnings, the world changed and now they were selling at 15 or 20 times.

But how would you have known when to get out? As they got lower and lower, did they not seem ever better buys? Whatever had kept you in at the top — wouldn’t you have had even more reason to stay in as the stocks got cheaper?

The Nifty 50 — the Avons and Cokes and Disneys and IBMs — thrived, for the most part. It was their stock prices, not their businesses, that got creamed. What’s more, in under three decades they saw their stock prices recover to and surpass their previous highs. (Well, not Avon or Polaroid, but many of them.) And now many of them are back selling at 40 or 50 times again.

Could something like this happen to AOL, selling for 650 times earnings? Or to Yahoo, selling for 1200 times earnings? Or to Amazon, selling at 225 times losses?

They’re different animals, presumably at a much earlier stage in their astonishing growth trajectories than the Nifty 50 were in 1972. But I wouldn’t rush out to buy them at these prices.

I think much of their bright future may already be discounted.

And in case one of them ever hit a snag — well, you could be talking about a price/earnings ratio under 90. (Gasp.)


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