Valuing Those Internet Stocks

Even at these prices, there are strategies to play

Internet stocks have had a wild ride--and it is getting wilder with each passing day. Inc. sold just $610 million in books and CDs last year and lost money, but its $20 billion market value makes it worth $5 billion more than Sears Roebuck & Co. So it comes as no surprise that the conventional wisdom holds that Internet stocks are headed for a crash.

Still, investors interested in high-growth companies have few better places to turn. Consumer commerce over the Net leaped more than 200% last year, to $13 billion, and should grow at least 120% again this year, predicts the Boston Consulting Group Inc. Business-to-business commerce over the Net, worth $50 billion in 1998, will grow at least as fast as the consumer market this year.

The wild price swings are not about to end--but neither will the growth in Internet commerce. Here is the case for Internet stocks.

Many top tech-fund managers scoff at the high prices of Net stocks. If they're staying away, why shouldn't I?

Because they're going to buy Net stocks anyway--they have to. Prudential Securities Inc. market strategist Claudia Mott figures that half of the 14% gain in the stocks of the Standard & Poor's 500-stock index in last year's fourth quarter was attributable to Internet stocks, and Internet stocks made significant contributions to other indexes as well. Thus fund managers "will either have to own Internet stocks or be very proficient in picking other stocks" if they want to beat their benchmarks this year, says Brian E. Stack, manager of the MFS New Discovery Fund.

So where's the best place to look for Internet stocks?

One tried-and-true method is to pick companies likely to emerge as a dominant franchise, capable of sustaining a high growth rate. Some top investors own only the biggest Internet stock: America Online Inc. Fidelity Magellan manager Robert E. Stansky made it his second-largest holding in the fourth quarter of 1998. He would have bought other top Net stocks but couldn't buy enough shares at low enough prices to help the performance of his fund. It's a safe bet he's going to buy more on dips this year.

Ron Elijah, manager of the Robertson Stephens Information Age fund, owns Amazon, AOL, and Yahoo!. Charles A. "Chip" Morris, who runs T. Rowe Price's Science & Technology Fund, owns AOL and E*Trade. Stack, a small-cap specialist, owns Sportsline USA Inc. and Scholastic Corp. Elijah and Morris own companies such as Cisco Systems Inc. and Sun Microsystems Inc. They're not pure Net plays, but their growth is closely tied to the Net.

Of course, retail investors can always leave Internet investing to a mutual fund. Internet funds, such as Munder Capital Management's NetNet fund (up 24.5% this year through Jan. 26), were among the country's top-performing funds last year.

If everyone's so sure there's going to be a correction in Net stocks, why invest now?

Not everyone should. Buying Internet companies with loopy valuations is a gamble. As long as companies such as eBay Inc. trade at as high as 2,000 times expected 1999 earnings, you might as well buy a lottery ticket. Shares in companies that show even the slightest problems stand to get decimated. "These are virtual casino stocks," says T. Rowe Price's Morris.

The key is to buy on dips the stocks you want to own. In the week of Jan. 18, many big Net stocks fell nearly 50%, and they're already moving back up. Elijah picked up in the low 90s, and it moved to 115 within a week. "So what if it's valued more than Sears," he says. Amazon's fourth-quarter sales nearly quadrupled over 1997, "and compared to that, Sears is dead," he says.

Not everyone is willing to bet that Amazon can sustain such growth. Yet Elijah, a savvy tech investor with years of experience, has made a tidy return from the investment. He knows that Internet companies, possibly including Amazon, are going to crash hard at some point, if not several times. Even so, Net stocks are by far the most powerful growth machines to hit the markets in a long time.

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