TCS Daily

Something Wild

By James K. Glassman - February 26, 2002 12:00 AM

A company called PayPal, which makes it easy to make purchases and transfer money online, went public on Feb. 15 and jumped 55 percent the first day. The press, predictably, greeted this success with snickers. Typical was a report on "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 percent. 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 percent -- 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 percent 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 (, 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 percent. But, again, the number of losers overwhelmed the number of winners, and half the stocks lost more than 50 percent 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 percent; the average annual increase in stock price was 41 percent. Again, this is just what you would expect.'s stock has collapsed because the company has never made money, but Oracle stock has risen an average of 43 percent a year because its earnings have risen an average of 42 percent 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.

Originally appeared in The Washington Post


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