Valuation of New Economy Stocks Throws Up the Same Old Dilemma
Byline: ANDREW ALEXANDER
HOW does one value new technology stocks? It is perhaps the most difficult question that investors, big or small, face these days.
If a company has an actual profits record and a realistic business plan, it may not be too difficult.
However, with many dotcom companies there is little to go on except ambition. The market itself has little idea of underlying value as can be seen from the fact that since November the tech-MARK 100 has more than doubled and then fallen by 35pc.
The fact that valuations can contain an element of madness is demonstrated by stock prices in the supposedly more sophisticated US market. A team of economists recently calculated that the top four US hi-tech firms - Microsoft, Cisco, AOL (premerger) and Yahoo - would have to grow profits by an average 30pc a year for 20 years to acquire what are currently regarded as standard valuations in terms of profits.
The catch is that, according to whether an earnings multiple of 15 or 30 is applied to the profits, the four firms' market valuation would then represent half or all of the American GDP likely by that date.
Mark Lambert, co-head of telecoms research at Merrill Lynch, is offering some clear thinking on the whole valuation question.
A stock might be rated on the net present value of future cash flows, he says. But of course future cash flows in high technology involve masses of guesswork.
The old-fashioned approach of estimating future (and distant) profits and calculating a prospective earnings multiple is not recommended. These businesses are international and accountancy standards across the world vary considerably.
However, you might try 'benchmarking'. In telecommunications, for instance, you can look at Vodafone AirTouch or British Telecom, established and profitable businesses, and compare a target company with them in terms of customer base, prospective growth, capital adequacy and so on.
However, Lambert adds helpfully, 'real life is not so simple'.
Some companies, for instance, are fully floating (like BT) but not others (like the German and Italian partly-privatised businesses).
Then there is the obvious issue of 'index characteristics'. Is the company in telecoms or pharmaceuticals or software? …