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How to value Net stocks?
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May 6, 1999: 5:12 p.m. ET
Tech managers have some tricks for small investors to calculate the value of stocks
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NEW YORK (CNNfn) - Besides the threat of the "Internet bubble," the toughest part of Internet stocks is trying to figure out their value.
But two leading technology managers at a conference this week have some methods to take the mystery out of high-flying stock valuations that don't have any earnings to back them up.
"This tells you what is obscenely valued," said Chip Morris, manager of T. Rowe Price Science & Technology Fund, at Morningstar's annual mutual-fund conference in Chicago.
A 'practical' approach
Most Internet companies haven't made profits and don't have price to earnings ratios, or p/e's. (The p/e is the price of the stock divided by the earnings per share. A stock selling for $100 a share that earned $2 a share last year has a p/e of 50).
So Morris has figured out something he calls the "practical p/e" that incorporates what these companies are promising in revenues.
He starts with the market capitalization and divides it by four times the latest quarter's revenues. He takes this price to revenue multiple and divides it by the company's promised net margin when it becomes profitable. That number is the practical p/e.
"It takes the mystery out of Internet stocks," Morris said. "This eliminates all the mystery if they don't have earnings."
For example, say Amazon.com has a market capitalization of $21 billion. Take expected 1999 revenues of $1.4 billion and divide that by a promised net margin of 7 percent. That gives you a practical p/e of 210.
Morris said individual investors can use the calculation to figure out companies that offer the most reasonable practical p/e's.
Using a media model
Bill Keithler, manager of the Invesco Technology II Fund, pins a number on Internet stocks by calculating revenues per subscriber.
For example, stocks like America Online (AOL) are basically media companies, he said.
"They aggregate eyeballs," Keithler explained. They get revenue from subscribers and advertisers. They also get revenue from e-commerce arrangements where they rent space to other vendors or take a percentage of the items the vendors sell.
Keithler divides the total revenue by the total number of subscribers to get the revenue per subscriber. For example, if AOL has expected earnings of $4 billion in 1999 and 18 million subscribers, the revenue per subscriber is $222.
Then he estimates future revenue and subscribers and discounts the number back to arrive at today's cash value.
The Invesco fund's top Internet holding is AOL. He also owns Inktomi (INK), CMGI (CMGI), Exodus (EXDS), Broadcast.com (BCST), Verio (VRIO), and Concentric Network (CNCX).
The analysis doesn't work as well for online communities or "content" companies, however.
For example, communities like Geocities, acquired by Yahoo!, haven't been that successful in bringing in revenue. Such businesses make a lot more sense as part of a big portal like Yahoo!
Content companies are valued based on the worth of their libraries, but the problem is for the most part their archives aren't worth that much.
Still cautious
T. Rowe Price funds are generally light on Internet stocks because of the low likelihood that many will live up to their billing, said company spokesman Steve Norwitz. At the conference, Morris and other technology managers expressed caution about the sector.
Morris said his fund owns three companies that are pure Internet plays. One is AOL. Another is Softbank, a Japanese software company that owns stakes in Yahoo! (YHOO) and e*Trade (EGRP). The third is PSINet (PSIX), which provides high-speed Internet access to global businesses.
The fund also owns big names with more of an indirect link to the Internet like Cisco (CSCO), Ascend Communications (ASND), Microsoft (MSFT), MCI WorldCom (WCOM) and Qwest Communications (QWST).
Morris likes some other names that have been overlooked by the market, including Adobe Systems (ADBE) and Analog Devices (ADI).
"Fortunately the market has broadened out and these stocks have been moving," Morris said.
-- by staff writer Martine Costello
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