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Some Dot Com Jewels Will Shine Again


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Some Dot-Com Jewels Will Shine Again

But investors need to be extremely discriminating

Forget The Millionaire Next Door. For that matter, forget all those Motley Fool books. For many investors who got swept up in the dot-com craze, the true story of 2000 would be titled How I Turned a $25,000 Internet Portfolio into $1.95 in Cash. And with the Goldman Sachs Internet Index now down 67% for the year and a growing number of former highfliers verging on bankruptcy, many investors may be content never to go near another dot-com.

But lest we forget, one old saw of investing is that the time to buy is when the blood is running down Wall Street. And many pundits believe that investors willing to dig carefully through the Internet rubble--and with the stomach to ride out the inevitable ups and downs of the Net sector--will find undervalued gems yielding big payoffs in a few years. "There are so many bargains right now," says money manager Alberto Vilar, whose Amerindo Technology Fund in 2000 has given back roughly two-thirds of the 249% gain it racked up in 1999. "They've thrown the baby out with the bathwater."

To be sure, investors dabbling in Net stocks must be extremely discriminating: The dot-com shakeout is far from over. Wall Street pros recommend against bottom-fishing among e-tailers, even those whose shares look tempting at a mere buck or two. "I think a number of e-tailers will fold in January if Christmas doesn't go well and [venture capitalists] refuse to put any more money in them," says Alan Loewenstein, co-manager of the John Hancock Technology Fund.STAYING POWER. And despite the sharp correction in recent months, many analysts warn that even media and e-commerce icons that have demonstrated staying power, such as Yahoo! Inc. (YHOO) and Amazon.com Inc. (AMZN), still look overvalued when measured by traditional standards. "I think Yahoo will be a survivor, but does it deserve a market cap of $23 billion? I just don't know at what price you should get in," says Loewenstein.

Similarly, some savvy analysts remain cautious about the outlook for Internet service providers, such as EarthLink Inc. (ELNK), and data carriers like Level 3 Communications Inc. (LVLT), which may see pressure on their margins. "ISP is ultimately a bandwidth business, and the price for bandwidth is heading toward free," says David Nadig, portfolio manager for the Open Fund.

The near-consensus pick among fund managers and analysts interviewed by BUSINESS WEEK: Web-hosting giant Exodus Communications Inc. (EXDS) Exodus stock plunged from a peak of 90 last April to around 35 in mid-December, largely on fears that its many dot-com clients could go belly-up. But First Analysis Securities Corp. analyst Howard Smith notes that Exodus now derives roughly 60% of its revenues from Old Guard companies such as Merrill Lynch & Co. (MER) "They have a broad base of customers who will survive the downturn," says Smith, who expects Exodus to turn profitable in late 2001.

Internet security software, too, is looking like a storm-proof sector. Many companies deferred spending on security while they dealt with the Y2K crisis, but analysts are now looking for the sector to grow 40% annually. SunTrust Equitable Securities analyst P. Sean Jackson's favorite companies are Check Point Software Technologies Ltd. (CHKP) and Internet Security Systems Inc. (ISSX) But given their lofty valuations, Jackson thinks better bargains may lie in Rainbow Technologies Inc. (RNBO), whose software speeds the transfer of encrypted data, and SafeNet Inc. (SFNT), which sells products to networking giant Cisco Systems (CSCO). "When you hear Cisco talking about its security solutions, there's a good bet that SafeNet's technology is embedded in them," he says.

Robertson Stephens Inc. analyst Scott W. Appleby believes the best Net play is E*Trade Group Inc. (EGRP) Its shares have tumbled from 20 to below 10 since September. But E*Trade has been diversifying. It now has healthy businesses in banking and corporate stock option programs and is expanding globally--with a presence now in 30 countries. And with E*Trade's stock now trading at less than 2 times book value--vs. 2.9 for traditional Street firms and 3.7 for other cyberbrokers--Appleby says E*Trade may get snapped up. "They'd make an excellent acquisition candidate," he says.STRONG BRAND. Paul G. Meeks, senior portfolio manager at Merrill Lynch Internet Strategies Fund, looks for companies reaching critical mass in their niche. Meeks likes homestore.com Inc. (HOMS) Thanks to close partnerships with the likes of the National Association of Realtors (NAR), it now has a dominant share of online real estate listings. Meeks also favors Getty Images Inc. (GETY), which controls more than 70 million images and some 30,000 hours of film--giving it a lock on the online images sold to ad agencies and other media companies.

Meeks is similarly bullish on TMP Worldwide Inc. (TMPW), whose Monster.com subsidiary has a strong brand among jobs and e-cruiting sites. "TMP is an absolute gift every time it hits the mid-50s," says Meeks, who expects TMP to boost profits more than 40% next year, to $1.31 a share. If so, TMP's shares, now in the mid-60s, "could easily go back into the 80s," he says.

But then, this is the Internet: No dot-com stock is without risk. Meeks cautions that if the economy dips into recession, demand for TMP's placement services could fall. And the government is reviewing homestore's partnerships to determine if--a la Microsoft Corp.--they're inhibiting competition. But if you're willing to ride out such risks, now might be the time to take a flier on the beaten-down Internet sector. If the Web is here to stay, investors may never see these kinds of valuations again.By Dean FoustReturn to top


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