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Tale of Two Stocks, Amazon and Intuit, in a Crazed Market
by Christopher Byron
How does that go again about the Efficient Market-you know, the bit
about everything that can possibly be known about a stock being
already reflected in the current price of the shares so that you
can't get the drop on folks by buying or selling before others see
what you've just spotted?
If that's so-or even a little bit so-then how do you explain the fact
that even as you read these words a fundamentally worthless Internet
stock like Amazon.com Inc. is selling on Wall Street for more than
the gross national products of Luxembourg and Iceland combined,
whereas one of the few consistently profitable-and steadily
growing-Internet-based companies in existence (Intuit Inc.) is
trading at 30 percent Amazon's value even though the company is just
as large as Amazon, is competing in a more promising arena of the
Internet market, has a better management team, a much longer track
record and can look forward to a much brighter future?
The fact is, you can't explain it-any more than you can explain why
the market as a whole is now selling for 24 times current earnings
even though the average of the past five years has been a
price-earnings ratio of 15, and for the last quarter-century the
ratio has been more like 10 times current earnings.
In short, everyone knows the market is overvalued, but no one cares
because everyone agrees that it doesn't matter just so long as prices
keep rising. And prices will keep rising so long as the Federal
Reserve, for all its blustering about inflation lurking just around
the corner, continues to print money in quantities greater than the
growth rate of the economy as a whole. The excess simply keeps
pouring into stocks, fueling the financial boom on Wall Street.
It's hard to see how this will end, either, since the Federal Reserve
has now climbed aboard a tiger it cannot easily dismount. Having
cranked open the monetary spigot in the autumn of 1998 to keep a
half-dozen private hedge funds from collapsing, the Fed told the
world that, when runway speculation threatens the stability of the
economy as a whole, the regulators will do whatever is necessary to
prevent a collapse-a message that the market has properly read as a
Government guarantee against failure.
Call it a stealth-F.D.I.C. insurance program in which the wealth of
the nation is being transferred from banks and real estate into
stocks, with the Federal Reserve emerging as an implicit guarantor
that a collapse of financial assets will not be permitted to occur.
For momentum-driven fund managers, this has been like throwing
gasoline on a fire, because it means that, in the end, the more
overpriced the market gets, the less likely the Fed will be to permit
a collapse. Thus, though the economy as a whole keeps plugging along
at an average 4 percent annual growth rate, the stock market
itself-propelled by barely a dozen momentum-driven superstocks-keeps
hurtling upward, year after year, at nine times that rate.
That this is an unsustainable situation should be-and I believe,
indeed is-obvious to everyone, including Alan Greenspan at the Fed,
who has lately begun trying to wriggle out of his bind by talking of
the need to raise interest rates without actually having to do it,
while citing as a reason the looming threat of inflation, which
simply isn't revealing itself in the data. As a result, every time he
opens his mouth to begin publicly shadow boxing anew with his own
personal phantoms, he loses credibility on Wall Street, and the
markets simply take off again.
It is this situation that has created pricing inefficiencies like the
anomalous disparity between Amazon on the one hand and Intuit on the
other. Amazon reached the preposterous price level it now enjoys not
because it is a well-managed enterprise, or has any sort of future,
but simply because it caught a roaring case of Big Mo. By contrast,
Intuit was never similarly stricken, and as a result it now looks,
comparatively speaking, like the most undervalued stock of all time.
The history of the Amazon situation is familiar enough. Between the
time this Internet retailing operation went public in the spring of
1997 and this last April, when the entire Internet sector flamed out,
Amazon was the momentum stock on Wall Street, soaring nearly 6,000
percent in value in two years' time, creating a market capitalization
in investor portfolios that eventually topped $35 billion.
Fund managers weren't buying this stock because they thought it had
value or long-term promise. They were buying it because everyone else
was buying it-in the process determinedly ignoring a consistently
repeated message from Jeff Bezos, the founder and principal owner of
the company, that he really didn't give a damn whether Amazon ever
made any money or not, and that all he was really interested in doing
was spending every dime he could get his hands on to turn the Amazon
Web site into one-stop shopping for every consumer product on earth.
Not only has this resulted in Amazon having by now piled up an
unbelievable $1.5 billion debt load, but the borrowing has come in
the face of accumulating evidence that the entire business model for
consumer retailing on the web is fatally flawed: With almost no
barriers to entry into the retailing arena, just about anyone can
open a Web site and grab away customers by simply selling below cost.
This, of course, is now forcing every established business on the Web
to spend vastly more on marketing and promotion than had ever been
anticipated, simply to stop the erosion of its own business.
Now, the momentum fund money has moved on from the Internet's
consumer retailing sector, to "e-business" and Internet
"infrastructure" stocks, fueling a whole new crop of runaway I.P.O.
deals. Thus we have cases like Sycamore Networks Inc., an Internet
switch-and-router company, which went public on Oct. 22 at $38 and
opened for after-market trading at $270.
Meanwhile, Amazon has been left by the roadside. At its current price
of $65 per share, the stock has lost 41.2 percent of its value while
the Dow Jones industrial average has dropped only about 1 percent
during the period.
Compare all that to Intuit, which never caught fire with Big Mo in
the first place. True, at a current quote of roughly $32 per share,
the stock is selling for close to triple its split-adjusted price of
three years ago. But though its revenues have grown by only 57
percent during the period, its earnings have soared from negative
$20.7 million to positive $376 million. One weak area: operating cash
flow, which has grown by a steady but not terribly impressive 20
percent during the period, to $73 million for the year ended this
last July.
That growth would in fact have been much greater if the company had
not been investing huge amounts in the growth of its own business.
In doing so, the company has cemented its position as the premier
supplier of accounting, financial management and tax-preparation
tools to individuals and small business throughout America, by far
the fastest growing demographic sector of the economy.
Meanwhile, the company has been aggressively moving more and more of
its business onto the Web itself-a process that has gone largely
unnoticed on Wall Street, where the momentum players have been
blindly chasing after stocks like Amazon instead.
Of all the companies that are involved in consumer retailing, it is
hard to think of a company better positioned than Intuit to migrate
to the Web-and make money in the process. The company has an
unshakable lock on almost every desktop-based financial software
service there is, from its "Quicken" personal financial management
software (which is much better and easier to use than Microsoft
Corporation's competing "Money" product), to its Turbotax software
for Federal and state income tax preparation. One of every six tax
returns in America are now prepared and filed using Turbotax-and with
no meaningful competition in the market, this is a business that can
and will grow for many years before it even begins to mature.
Most importantly, all these offerings are being seamlessly
transferred by Intuit to its Internet servers. Intuit's Internet
revenues already account for 15 percent of the entire business, and
by the year after next they could equal close to half the company's
total revenues.
For consumers themselves, the push means that instead of having to
install a new software program on their home computers each year to
do their taxes, for instance, they'll be able to keep their tax
records, financial accounts and whatnot on Intuit's computer
instead-thus enabling them to access them whenever they want,
wherever they are in the world.
For Intuit, the operating economies in this setup are astounding. Not
only does the company already have the established brands in the
field (its brand names are thus well established and unrivaled on the
Web already), but by moving to the Web, Intuit's distribution costs
increasingly disappear. That's why the company is pushing so
aggressively to migrate its operations to the Web: More of every
dollar of revenue falls to the bottom line.
For all that, Intuit is currently trading at 16 times current
earnings, which is a lower multiple than even many utilities
companies. By contrast, Intuit's peer group-the application software
sector-is now selling for 77 times earnings.
Meanwhile, the company is selling at half the price-to-sales ratio of
its peer group, one-third the price-to-book-value ratio, and
one-fifth the price-to-cash-flow ratio-all this even though its
pretax and net profit margins, as well as its returns on equity,
assets and invested capital are all vastly better than those of its
peers. Moreover, Intuit has barely any debt, has more than $500
million of cash on hand and another $700 million of easily marketable
securities, and $1.5 billion of shareholder equity. This is a balance
sheet to die for.
Analysts have underestimated Intuit's earnings for the last three
quarters in a row, and their 20 percent growth rate forecast for the
year ahead could turn out to be short of the mark once again. So why
they aren't pounding the table on this stock I don't know, except
perhaps that "value" stocks don't seem to be of interest to anyone
anymore. Who wants to buy an undervalued stock when it's only the
overvalued ones that seem to go up?
Meanwhile, there the stock sits, a seeming orphan of the digital age,
as momentum investors stream past it in all directions as they chase
weak-to-worthless rivals to the moon, secure in the belief that Mr.
Greenspan will never let them fall. Some age we live in. Go figure.
You can reach me by e-mail at cbyron1@home.com.
This column ran on page 36 in the 11/15/99 edition of The New York Observer.