Memorial Day weekend symbolizes the start of the American summer. Forget that stuff about honoring the war dead. Now it's become a three-day orgy of parades and barbecues and swimming pool openings.
And to us stockholders, Memorial Day is especially welcome this year because we'll have only four stock market days to worry about this week. Think of it as a 20-percent-off-worrying sale.
There's plenty to worry about -- not just Internet stocks. For the first time since last fall, when Fed Chairman Alan Greenspan inadvertently revived stock prices by cutting interest rates to forestall a worldwide financial panic, it's time for any sensible investor to be nervous. And Internet stock investors should be especially nervous because Net stock prices depend on faith, not economics. Thus, they're especially vulnerable.
Here's the big picture. Greenspan, worshiped as a divinity by much of the stock market, is in my humble opinion trying to talk down stock prices in his typical fashion. Obliquely. But unlike his "irrational exuberance" utterance in December 1996, Greenspan this time is laying groundwork.
His argument, according to cognoscenti, goes like this: Higher stock prices have raised consumer spending so high that it is putting inflationary pressures on the economy. Hence, the Fed may be obliged to raise interest rates to drive down spending, stock prices and inflation.
Interest rates affect stock prices because higher rates make bonds and money market funds more competitive with stocks, and also cause analysts to give less value to a dollar of company earnings. (That is, if there are earnings, an uncommon situation for Net stocks.)
And there's a big psychological component, too. When the S&P 500 was at its peak two weeks ago, it was so high, relative to corporate profits, that any problem, real or imagined, could whack it. Greenspan's warnings pose a real problem. So the market, ever adaptable, is preparing for rate increases.
Rather than discuss the general market, a topic that many of us are heartily sick of by now, let's relate this big picture to "established" Net stocks, which were all that many people wanted to talk about last week. And let me explain why I won't go near Internet stocks at anything like their current valuation, even though I agree that technology is driving the U.S. economy and that the Internet's potential for business use is unlimited.
It's a price question. At Friday's closing prices, the combined market value of the 40 stocks in the Dow Jones Internet index was $37.6 billion (26 percent) below its all-time high on April 13 -- but still up 56 percent from the start of the year. And these stocks weren't cheap then.
Here's the deal. No matter how wonderful the Internet is and how much online financial news and stock trading have "empowered" millions of small investors, there is still one eternal investing rule that people such as me hold dear. Which is this: When you buy a stock, you're buying a piece of a business. And the price you pay for that piece matters, assuming you're not looking for just a quick trade.
Internet stocks have risen so far so fast that people have invented new ways to value them. But in the long run, a company has to make money to validate its stock price. Hence even though I'm using Yahoo Financial to get prices for this article and I think Yahoo is a fine company with great prospects, I wouldn't touch the stock. Why? Because at Friday's price of $148, the stock market values Yahoo's 253.7 million shares and options at $37.5 billion. If you make the very, very generous assumption that Yahoo is the next Microsoft, which sells at 63 times its most recent 12-months earnings, Yahoo has to be earning about $600 million a year to justify Friday's price. That's more than double Yahoo's total revenue. Yes, Yahoo is way down from its high of $244 a share on April 6. But it's not cheap.
No matter how much you might believe in individual Net stocks, they're incredibly risky. The all-time-peak-to-Friday declines of 32 percent, 39 percent and 46 percent in AOL, Yahoo and Amazon.com, respectively, are trivial compared with some falls. Take Egghead.com, which closed its software stores to become a pure Internet play. Its stock reached $40.25 in November. Friday's price: $11.06 1/4, down 73 percent.
Playing the initial public offering game is risky, too. It's one thing to buy these stocks at their IPO prices and flip them for a quick profit. But small investors get a hot IPO at the offering price as often as we win the Powerball lottery. If you buy in the aftermarket, look out. Two examples: CBS Marketwatch.com went public at $17 on Jan. 15 and reached $130 that day. Friday's close: $51.87 1/2. TheStreet.com, which went public at $19 on May 11, sold above $70 that day. Friday's price: $35.75.
The way to succeed in the market the past few years, especially with the big Net stocks, has been to buy when prices dip. Some players were out doing that last week. They may make fortunes, but I sure wouldn't bet on it. As for me, the only dips I'll deal with for a while are on chips or in a swimming pool. Welcome to summer.
Rich Thomas and Anjali Arora contributed to this column. Sloan is Newsweek's Wall Street editor. His e-mail address is firstname.lastname@example.org