Exuberance on [and about] the Net
When many investors are influenced by their psychological biases in a common way, the overall market will be affected. This is best illustrated by the most recent investor mania - the irrational exuberance for Internet companies. Many investors and analysts have been puzzled by the extremely high valuations of Internet firms. For example, when the historical average P/E ratio of the market is around 15, what is the justification for Yahoo!'s P/E of 1,300 or eBa/s P/E of 3,300 in late 1999? Many analysts concluded that new valuation measures were needed for this new revolution in the economy.
Or consider the valuation of eToys.1 eToys is an online toy retailer that went public in 1999. Shortly after the IPO, the high price of the stock created a total company value of $8 billion. Typical of Internet companies, eToys had negative earnings of $28.6 million from $30 million in sales. The natural comparison for eToys is Toys "R" Us. Toys "R" Us is the "old economy" leading toy retailer. Even though Toys "R" Us had profits of $376 million, it had a market value of only $6 billion; that is, Toys "R" Us had a lower market valuation than eToys even though it earned 12 times more in profits than eToys had in sales!
This is even more astounding when you realize that there is a very low barrier to entry for companies getting on the Web. After all, kids started many of the Internet firms on only a shoestring. Indeed, Toys "R" Us quickly developed its own online retail capability and eToys' market capitalization fell from $8 billion to $29 million.
A ROSE.COM BY ANY OTHER NAME
In the immortal words of Federal Reserve Chairman Alan Greenspan, it appears that investors may have gotten "irrationally exuberant" about Internet stocks. Some companies even changed their names to FancyNewName.com. Investors went dotcom crazy and scooped up shares of any company related to the Internet - they could tell which companies were Internet-related by looking at their names.
Look, for example, at the case of Computer Literacy Inc., an online retailer of technology books which customers kept misspelling (or forgetting). Its Internet address was computerliteracy.com, so Computer Literacy Inc. changed its online name to fatbrain.com. Note that this company had already been providing its service over the Internet. The change was in name only, not in business strategy. But when word leaked out about the name change, the online stock discussion groups sizzled and the stock climbed 33% in one day!
From mid-1998 to mid-1999, 147 publicly traded companies changed to new names with a dotcom, dotnet, or the word Internet.2 During the three weeks after a company's name-change announcement, its stock beat the market by an average of 38%. All kinds of companies got in on the action. Some of them were already pure Internet companies, and these beat the market by 57% three weeks following the name change. Other companies changing names had only some Internet experience - these earned 35% over the market. Companies who were changing their names and also changing their focus from non-Internet to Internet beat the market by 16%. In fact, even companies with little or no Internet experience enjoyed the large stock price increases after changing their names. These firms had a non-Internet core business, and there was no evidence that they had the expertise or experience to be successful on the Internet. Yet, net-crazy traders bid up their stock prices so that they beat the market by 48%, second only to the pure Internet companies! These huge increases in stock prices did not diminish over the following three months. Investors appeared to be eager to throw money at Internet companies. The mania is illustrated in Figure 13.1.
Consider the case of AppNet Systems Inc.3 AppNet, a private firm, decided to go public and registered with the SEC to conduct an IPO and trade under the symbol APPN. The time between an SEC filing and the actual offering is usually measured in months. Another small company, Appian Technology, was already trading on the over-the-counter (OTC) bulletin board market under the same ticker symbol.
The mania set in. Net-crazed traders touted APPN in chat rooms. Not wanting to miss out on the latest dotcom success story, investors snapped up shares of APPN. Of course, AppNet had not had their IPO yet. The shares that were traded were those of Appian. It is not clear why these traders thought they could buy and sell shares of a stock that had yet to have its IPO. This was not an error made by just a few investors. This was a massive case of mistaken identity On the day before the AppNet filing went public, Appian experienced a total volume of 200 shares. Yes, you read that correctly - only 200 shares were traded that whole day. During the two days after the filing, over 7.3 million shares of Appian were traded. Also during these two days, the stock of tiny Appian soared 142,757%. Again, you did not read that wrong. It is a statement on how overly exuberant investors were for dotcom companies - that investors would drive up the price so high on the wrong company is impressive.
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