| This week's question might very well be my favorite of all
time. Dear Scott,
What happened?
Hmmmm. I sense we have yet another reader who invested
heavily in the NASDAQ. That Index has come crashing down. As of Thursday, Nov. 30 (when I
am writing this column), it is down 36 percent from the beginning of the year and 48
percent from its high in March. Now I will dispense with the typical "you should
diversify" routine and instead call in Dr. Quincy to perform a post mortem on the
NASDAQ. Here are the good coroner's results.
Could You Have Seen it Coming?
The answer is both yes and no. No, I doubt that many people
foresaw the absolute decline in the Index. However, many analysts were warning about the
risks inherent in the high-technology stocks that make up the bulk of the NASDAQ. (For
proof, see my beginning of the year commentary. So yes, at least the risks inherent in the
NASDAQ were evident. The question is, why did so many people, not only individual
investors but also professional money managers, ignore the danger signs? Ah, the answer is
that same old disease that afflicts so many people during a good market, the dreaded overconfidentitis.
Yes, we all see the risk — but unfortunately, too many of us feel that our own
abilities will overcome the risk. That confidence was bolstered by NASDAQ's great returns
— 83 percent for 1999. To see the kind of euphoria that professional analysts had
earlier this year, let's look at a few case studies.
Dialing for Exuberance
In December of 1999, an analyst following Qualcomm, a
wireless communication company, predicted that the price of the stock would double,
despite the fact that it had already increased over twenty-fivefold since the beginning of
the year. Since expected earnings were about one dollar per share, that made the
anticipated price/earnings ratio 250. In part because of that recommendation, the stock
was bid up to 200 by the beginning of this year. Neither the analysts nor investors seemed
fearful of the competition, which is fierce in the telecom industry. Yesterday the stock
closed at 80 1/4 , a decline of 60 percent.
Hubris: The Final Frontier
Early this year, analysts were beaming over priceline.com,
the "name your price" shopping service that had William Shatner as a pitchman.
One Wall Street analyst, who rated the stock a strong buy, expected revenue for 2000 to be
twice as much as in 1999. Another analyst, who also rated it a strong buy, was encouraged
by its recent gross profit. Neither analyst seemed worried that it would be relatively
easy for competitors to enter the market and that the company would still be projecting an
overall net loss for 2000. Based on such optimistic reports, the stock was bid up to 104
in early March. The stock is now selling for 2 1/2 , a loss of 98 percent.
I P Ohhhhhhhhhhhhhhhh
In December 1999, VA Linux Systems had its initial public
offering. The company has long been the darling of independent thinkers because it
produces an operating system that comp*tes with Windows (unfortunately, since I am typing
this column in a Windows program, my computer won't let me type the phrase "comp*tes
with Windows" without the *). The IPO had a wide following, and the price increased
almost sevenfold in one day, producing, at the time, the largest single-day gain in IPO
history.
Now, in my career I have met many investment bankers and
chief financial officers, and in general they are not dumb people. Prior to the IPO, the
investment bankers met with the CFO of Linux and felt that a good offering price would be
$30 per share. And yet investors in their bidding frenzy were willing to pay $239 on the
first day? What were they thinking? (It's actually worse than that — in the middle of
the day, someone paid $320 per share.) The stock is now selling for 8 3/8, a decline of 97
percent. And you thought the Department of Justice had a difficult time in challenging
Microsoft.
So Who's Responsible?
Well, the sad truth is, we all are. Every pundit who talked
about the new economy — the one in which the NASDAQ could not possibly take such a
beating. Every analyst who gave strong buy recommendations to stocks of companies that
showed no plan of how they would ever turn a profit. And, every individual purchaser who
bought blindly into NASDAQ based on the single premise that what went up last year was
certain to go up again this year.
Have we learned our lesson?
Editor's note: mPower analysts David Silveira and Dan
Price helped a lot with this column. |
