Investing in Internet Stocks

Investing in internet stocks looks simpler than it is. As the dot-com bust shows, it is anything but simple. Identifying internet stocks that can do well needs a lot of discipline and quick thinking. Trying to time the market can be a futile exercise. While investing, one ought to be careful to avoid speculating. Speculators are not concerned about a stock’s intrinsic value and are more worried about the short term fluctuations so that they can profit by buying low and selling high. On the other hand, investors are more concerned about the value of the stock and are not unduly bothered by the near term fluctuations.

Let us analyze a couple of stocks that have done well from an investor’s point of view. (AMZN) while hovering around the $20 price range in 2003 has risen to $92 in 2007. That’s a whopping 362% gain. Why is Amazon such a big success? When Amazon started addressing the customer’s need to shop online, its business model ought to have been clear to the brick-and-mortar companies. Although (BKS) competes with, most of the other brick-and-mortar companies failed to address the online customer’s needs.

When (GOOG) started at less than $100 in 2004, nobody expected it to rise to $585 in 2007, a 485% gain. While every other search engine/portal/search aggregator declined (or fell completely off the map), captures more consumer attention than it did in 2003. In 2001, out of the top 25 sites, 10 were some form of search engine or portal. With the exception of the MSN, Yahoo and Google, the rest have fallen out of the picture.

What should one look at before investing in internet stocks?
1) Does the company address a business need?
Careful analysis of the business need addressed by the company along with a detailed study of the market forces is essential to predicting an investment’s success in the market place. A long term focus is key to assessing a company’s ability to succeed in the market place.

2) Is P/E ratio important?
Chances are you’ve heard the term price/earnings ratio (P/E ratio) used before. When it comes to valuing stocks, the price/earnings ratio is one of the oldest and most frequently used metrics. Although a simple indicator to calculate, the P/E is actually quite difficult to interpret. It can be extremely informative in some situations, while at other times it is next to meaningless. As a result, investors often misuse this term and place more value in the P/E than is warranted. Theoretically, a stock’s P/E tells us how much investors are willing to pay per dollar of earnings. For this reason it’s also called the “multiple” of a stock. In other words, a P/E ratio of 20 suggests that investors in the stock are willing to pay $20 for every $1 of earnings that the company generates. However, this is a far too simplistic way of viewing the P/E because it fails to take into account the company’s growth prospects.

3) Should you pay attention to the company’s growth?
Listening to a company’s earnings announcement is key to analyzing a company’s growth prospects. If a company announces good earnings but projects dim prospects for growth, maybe it is time for the investor to look elsewhere. On the other hand, even if the earnings for the current quarter/year are not that rosy, robust growth estimates might point to good earnings in the future.

4) Are insiders dumping?
If company executives/insiders are selling the shares in droves, maybe they aren’t that positive about the company’s share value growth in the future. For this reason, it is important to analyze this information if possible.

5) Are insiders leaving the company?
The exit of established executives may be a true indicator of the management ability of the company. If seasoned leaders are leaving for better pastures, maybe it is time for the investor to get out of the company as well. However, if this exit is augmented by a reliance on a smaller, leaner and more fit management team, the investor may opt to stay in. For this reason, a long-term view is important.

6) History is important
The dot-com boom of the 1990s was an aberration in terms of high stock prices for Internet companies. During the heyday of the dot-coms, valuations for anything Internet-related reached outrageous and unsustainable levels. Although valuations may not reach that level in the future, a flight to solid internet companies is inevitable.

7) Long-term vision is key
Short-term focus is the reason many investors follow a company’s rise in stock price and buy high only to see it fall the very next day. If you follow an approach where you buy in installments, the low average buying price that you pay may see you profit from a company’s rising stock price in the future.

In general, paying attention to a company’s growth, the business need it fulfills, its history and long term vision is key to analyzing a company’s prospects in the market place. As explained above, an investor can profit by buying in installments when the price is low and selling when the price is high.