Tech Stocks Go Boom
By Jerry Knight
The technology companies that have become the engines driving the economy of the Washington region are now beginning to power the portfolios of investors as well.
In a dramatic transformation for investors who buy stocks in local companies, high-technology stocks have replaced the traditional "blue chips" as the best bets among stocks of District, Maryland and Virginia companies.
Look at a list of the 10 best-performing local stocks over the past five years and only two of them are high-technology companies – America Online Inc. of Dulles and Integral Systems Inc. of Lanham.
But look at the 10 best stocks for the past year alone and only three are not high-tech. And a closer look reveals that two of those three owe their success to technology. Capital One Financial of Falls Church, whose stock is up 130 percent over the past 12 months, is known as the technological leader of the credit card industry. United Payors & United Providers of Rockville, whose stock has more than doubled, automates the complex process of paying medical insurance claims. That leaves Atlantic Coast Airlines of Chantilly as the only non-technology company among the 10 best local investments for the last year.
The new dominance of local tech stocks is more noteworthy because 1998 has not been a great year for technology issues, which as a group have lagged the Dow Jones industrial average.
The trend to technology reflects fundamental economic changes that make tech companies more attractive than such traditionally golden investments as manufacturing, retailing and financial services.
"You're dealing with an economic growth picture that is slowing," explained Richard Cripps, chief investment strategist for Legg Mason Wood Walker, Maryland's biggest independent investment firm.
"What technology offers is much greater, more dynamic growth than the overall economy. That's what's powering it."
Cripps contrasts the growth potential of the burgeoning technology companies in Maryland and Virginia with the prospects of Bethlehem Steel, once the biggest business in Baltimore, and Mobil Corp., the biggest company based in the region. Both are battered by foreign competition that makes growth difficult, and Mobil agreed to merge with Exxon last week in hope of becoming a stronger global competitor.
But foreign competition poses no threat to the region's technology companies, said Guy Chance, managing director of market strategy for Scott & Stringfellow Inc. of Richmond.
"The United States of America is the technology leader of the world, hands down the technology leader of the world, so these stocks, we think, are going to perform very well," Chance said.
It is not only the global and economic trends but the kinds of companies based in the Washington region that are drawing investors, added Art Huprich, a technical analyst who works in the Baltimore office of Ferris, Baker Watts of Washington.
"The big innovations are taking place in medicine and technology, communications, the Internet," he said. Benefiting from heavy federal spending, those sectors have produced dozens of companies in the District and its suburbs.
Over the past dozen years, Cripps explained, the most important technology trend has been the growth of the personal computer and its integration into every aspect of American business. The computer revolution created Silicon Valley, Microsoft, Intel and that whole industry, mostly based on the West Coast.
For Washington investors, the most important innovation is the growth of the Internet. "That is clearly the most fundamental secular shift going on in the science and technology space today," said Chip Morris, president of the T. Rowe Price Science & Technology Fund, a $3.6 billion high-tech mutual fund run by the big Baltimore fund manager. (T. Rowe Price's own stock ranks eighth among District, Maryland and Virginia issues over the past five years, producing a 37.3 percent average annual return.)
The Washington region is awash in Internet infrastructure companies, many with highflying stocks. Shares of Netrix Corp., a Herndon switch maker, have doubled over the past 12 months, earning the company a spot on the list of the year's 10 best stocks. The stock of PSINet Inc. of Herndon is up 19 percent from a year ago, the third-best performer among regional stocks in the past year. Vast amounts of Internet traffic move on hardware – switches, routers, cables – owned and operated by PSINet.
One group of companies bound to benefit from the Internet boom are those that are building the Web itself: "companies that provide Web servers and companies that provide infrastructure software, companies that provide communications gear to make sure that the Internet doesn't fall down on itself," Morris said in an interview distributed to the fund's clients.
But while the PC revolution mostly benefited companies making the hardware and software, the Internet revolution will have more impact on companies using the Net than those building it, Morris said.
"The real application of the Internet is electronic commerce, and electronic commerce touches many, many companies," Morris said. "It is all about different ways of retailing. It is all about different ways of providing financial services."
The new Net commerce companies include Telebanc Financial Corp. of Arlington, whose stock is the fourth-best performer among Washington companies over the past year, up 153 percent. Telebanc is the nation's biggest Internet bank. Except for a teller at its headquarters, Telebanc doesn't have a single branch, but it has almost $2 billion in assets and thousands of customers who do all their banking via home computer, telephone and fax.
AOL, of course, is the region's premier investment in the Internet revolution. In the process of becoming the nation's best-known Net company, AOL has become the Washington region's most successful tech stock. Whether measured by performance over the past year, the past five years or for any year in between, AOL ranks No. 1 among all stocks of companies in the District, Maryland and Virginia. AOL is the first tech stock to establish that kind of a track record. Between Dec. 1, 1997, and Dec. 1 of this year, AOL stock climbed from $19.25 a share to $89.87½. That huge increase this year helped boost the long-term performance of the stock.
But many investment analysts warn that such run-ups are the result of what could be a fad for Internet stocks. The joke du jour in the investment world is that all you have to do is add ".com" to any company's name and the stock will take off.
Falling victim to investment fads is one of the new dangers facing Washington investors in the era of tech stocks. To earn the rewards of investing in fast-growing technology companies, they must be willing to accept new risks and learn to play by new rules. Technology investors must learn to stomach the uncertainty of owning stocks whose value can fluctuate wildly, driven by speculators whose decisions are based on the latest rumor, not long-term performance.
The latest example of that gut-wrenching volatility came Thanksgiving week, when amateur investors, many of them trading on their home computers, developed a sudden appetite for Internet stocks. On the Friday after Thanksgiving the stocks of six Washington Internet companies swept to their highest levels of the year, a correlation explainable only as Internet fever. Every one of the stocks dropped the following Monday, when the fever subsided. A week later, five of the six stocks are still down, one has lost more than half its value, another a third.
Besides avoiding market manias, tech investors also must hit the books to learn the subtleties of packet switching, e-commerce, genetic sequencing and other trendy technologies so complicated that even industry insiders often can't judge which company has built a better mousetrap and which has a product that will be outmoded tomorrow.
The stock of Ciena Corp. of Linthicum soared past $90 a share last July, based on investor confidence that no other company could match its system for shoving more signals down a fiber optic cable. The technology made the company a takeover target, but the deal fell apart after investors learned that potential customers chose to buy another black box from a rival company. Three weeks after it hit $90, the stock was trading at $8 a share.
Ciena symbolizes another risk of the new era of tech investing. It is one of many companies so young that investors had to choose between getting in on the ground floor and buying before the company could prove itself. Wait and you miss the opportunity to make pioneering profits; jump too soon and your investment can die on the vine.
The reality is that investors who buy stock in start-up technology companies that are selling shares for the first time have about the same chance of making money as they do of calling a flipped coin correctly. Of the 53 local high-tech initial public offerings (IPOs) since 1995, 28 have been winners for investors and 25 had lost money as of Dec. 1. Investors who bought the half-dozen worst IPOs lost between 75 percent and 90 percent of their cash. Investors in the best local IPOs, on the other hand, earned the kind of profits that make people willing to risk their money on start-ups.
Shares of Network Solutions Inc., the Herndon company that licenses Internet addresses, have gone up more than 265 percent in 15 months, from $18 a share to $59.12½ on Friday. The stock of Visual Networks Inc., a Rockville company whose software makes big computer networks run better, is up more than 178 percent, from $12.50 a share to $35 since that company went public last year. Investors have doubled their money in less than a year on the IPO of Global Telesystems Inc. of McLean, which is building long-distance communications networks in Russia and Eastern Europe.
While the extraordinary performances of most technology stocks are based on sound and sustainable economic trends, that does not guarantee that investors can make money by buying tech stocks, particularly at today's prices, cautioned Eric Billings, one of the founders of Friedman, Billings, Ramsey Group Inc., the Arlington investment firm.
"Certainly there is something going on which is quite extraordinary and revolutionary. If we don't quite understand it, we certainly sense it and feel it," said Billings.
"The Internet is going to change the world as we know it. It's doing it. It's a powerful, powerful force. But from an investment perspective, there is a difference between that dynamic and the investment dynamic.
"To a substantial degree, a lot of these stocks are way, way ahead of themselves," Billings said, citing the phenomenal fall run-up in technology stocks and the ongoing Internet mania.
Tech stocks will continue to be among the best investments in the years ahead, he added. "But if you do a study a few years from today, you may not find tech stocks as prevalent. And if you do a study of the worst-performing stocks over three years, you'll probably see a few of these names on that list as well."
© Copyright 1998 The Washington Post Company