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Stocks such as Yahoo!, eBay, and America Online are stuck in the doldrums. "Investors are just not interested," says Ryan Jacob, manager of the downtrodden Jacob Internet Fund. "They've kind of moved on. In the same way that the market wasn't differentiating from high-quality and low-quality companies on the way up, during the correction there hasn't been any delineation between them either." Tom Taulli, senior Internet stock analyst at Internet.com, agrees. "Investors are just down on it," he says. "They don't want to hear about it, they don't want to deal with it. Nothing in the next couple of months will reverse that." NO SIGN OF AN UPTURN. Meanwhile, lower-tier Internet companies, including most recently Value America and Living.com, continue to close up shop. Sierra Izzard, market strategist at Internet Stock News, senses outright hostility toward the pure Internet plays. "Investors' perception is that the Internet was sort of a hoax and that a lot of these companies were nothing more than cleverly drafted business plans with no real path to profitability." To technical analysts, these stocks make for some coyote ugly charts. "They look horrible -- much worse than the rest of tech," says Edward Nicoski, technical analyst at U.S. Bancorp Piper Jaffray. He points to a pattern of descending rallies where the stocks never get close to previous highs. "Investors use every rally as a chance to sell," he says. What this adds up to is that investors who are hoping for a rebound in the fourth quarter -- something many analysts predict -- could be disappointed yet again. For the past two years, dot-com stocks have followed a pattern: First, a summertime correction, then a dramatic rise in the fall. But this year could be different. To be sure, the holiday season should drive more advertising and stronger sales, and many of the remaining e-tailers are likely to benefit from less competition now that so many weaker players are gone, says Greg Kyle, president of Pegasus Research, which studies Internet stocks. But few expect a blockbuster season. "I'm not so sure we're going to see much of an e-Christmas this year," says Jacob. Merrill Lynch analyst Henry Blodget's Aug. 7 research note in which he downgraded many stocks in the sector reiterates his opinion that "the going will likely be tough for even the best Internet stocks the next year or two." STILL NOT CHEAP. One obvious reason that even the best dot-com stocks are stalled is that the same momentum investors who drove the issues to such lofty heights have moved on to Internet-related tech themes such as infrastructure, networking, and business software. "Then you're left with people that analyze fundamentals," says Rosellen Papp, a partner and fund manager at L. Roy Papp & Associates. And the truth is, despite being 50% or more off their highs, many of these stocks are still too expensive for traditional investors. "They won't get cheap enough for us," Papp believes, adding that concerns about a slowing economy will also keep many investors away from these names. To be cheap on the basis of traditional stock-valuation measures, the price of many premier names would have to decline an additional 40% or more. Sanford Bernstein analyst Faye Landes issued a devastating report on Aug. 9 titled "The Internet Doesn't Change Everything," in which she rated Amazon.com "underperform" and eBay and Priceline "market perform." Worst of all, she said her methodology suggested price targets of $21 for Amazon, $22 for eBay, and $14 for Priceline. Those stocks are currently trading around $32, $50, and $25 a share, respectively. For these stocks to "grow into their valuations" -- Wall Street jargon for the notion that the companies eventually will get big and profitable enough to trade at prices comparable to other stocks -- they will have to grow very fast. "If you are going to pay 100 times earnings, you better believe [the company] is going to grow at a rapid rate for the next few years," says Chris Bonavico, portfolio manager of Transamerica Premier Aggressive Growth. A CONTRARIAN PLAY? And there are increasing signs that Internet growth is slowing. Amazon got crushed when it reported that revenues grew by only 1% from the first quarter to the second. And eBay has been punished as analysts have pointed out that the number of items listed to be auctioned has plateaued in recent months. Blodget has a nice way of putting it when he writes that these companies are inevitably "transitioning from hypergrowth to long-term growth." But no matter how you slice it, growth is slowing, and that is scaring investors away. Still, as Jacob, whose fund is down 50% this year, points out, "it is impossible to try and time the market." And there are a few encouraging signs that could lift some stocks. Jacob predicts a wave of consolidation in the sector. That should strengthen some companies, allowing them to reach the size and scale they need to turn a profit even without more capital from Wall Street, he says. More dot-coms could benefit from partnering with traditional companies. Beleaguered Amazon.com took that route with a recently announced deal to sell videos and toys with Toys 'R' Us. Some investors do best when going against the grain, buying into a sector when Wall Street's enthusiasm seems to be at its nadir. The truth is, there is little doubt that some dot-coms will eventually figure out how to make money by selling goods over the Internet, nor is there much doubt that Web advertising will be big business. But,if you choose that contrarian strategy, don't count on big gains anytime soon. Stone is an associate editor of Business Week Online |
