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Internet Stocks: Value and Trading Strategy. Rob Freund Petter Hellman Ole Hvidsten Jiong Shao Rick Solano. Main Points. Value in theory Internet shortcomings for traditional value Modifications to theory for Internet stocks Trading strategy Conclusion Questions. Value in Theory.

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Internet Stocks: Value and Trading Strategy

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Internet stocks value and trading strategy l.jpg

Internet Stocks: Value and Trading Strategy

Rob Freund

Petter Hellman

Ole Hvidsten

Jiong Shao

Rick Solano


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Main Points

  • Value in theory

  • Internet shortcomings for traditional value

  • Modifications to theory for Internet stocks

  • Trading strategy

  • Conclusion

  • Questions


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Value in Theory

  • Investors want money

  • Industry growth vs. age curve

  • New industry - growth important

  • Mature industry - returns important

Graph


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Internet Shortcomings

  • Modern valuation theory created during a time when there was no emerging society- convulsing technology

  • Valuation theory based on earnings and net income.

  • Internet terminal values are unclear.

  • Can’t use current performance to extrapolate future performance.


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Laying Odds on Success of Firm’s Value Proposition

Total Market Capitalization of Industry

(e.g. Retail: $1.45T %, FCF Margin = 5%)

{

Expected Market Cap position of firm (PV $)

(e.g. Amazon: Market Share = 10%

MCAP = $145B)

Payoff to investors if firm successful

Current Market Cap of firm

(e.g. Amazon MCAP as of 8-31-99 = $14.14B)

{

Bet placed by investors

Current Value of firm using existing financial performance baseline

(e.g. Not Applicable - no earnings)

Price of bet influenced by factors affecting expected future outcome (e.g. starting QB breaks leg day before Superbowl) - IN THIS CASE, MARKET HAS SET 10-1 ODDS ON AMAZON CROSSING THE FINISH LINE IN THIS POSITION


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Hypothesis for Future Returns

  • We must find a proxy to indicate the potential for future income.

  • Potential proxy candidates:

    • MCAP/Sales

    • PSSG

    • PSSA

    • Sales growth


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Trading Strategy

  • Sort stocks during a particular time period and pick top 25%

  • Stock sorted on the income proxy

  • Positions taken at the end of the second month following the quarter used for analysis

  • Returns calculated over three month holding period

  • Stock returns were compared to a “buy and hold” strategy of stocks included in the H & Q Internet Index

Results

Index


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Conclusion

  • Must use a proxy for earnings

  • A buy and hold strategy can be beaten

  • Current value is based on investor perceived future potential


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Questions?


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Industry Growth vs. Time

Growth

Rate

Return

Time


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Results of Various Sort-Trading Strategies

Using a simply MCAP to Sales ratio to sort yields the highest return


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MCAP to Sales and Sales Growth Ratio

  • Incorporate sales and sales growth into a valuation parameter

  • Based on PEG (price to earnings and earnings growth)

  • Formula - MCAP/(S*DS)

  • As the firm/industry matures, growth declines, so actual sales must pick up the value slack


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H & Q Internet index

Due to MCAP weighting - the index return has been significantly skewed by a few extraordinarily successful stocks


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Traditional vs. Internet

  • Traditional

    • Players exist and stable

    • Market size identifiable

    • Can estimate terminal value because market size known

    • Extrapolate current performance based on short-term management guidance

  • Internet

    • Terminal value unknown

    • Can’t use current performance to extrapolate

  • Factors determining mature market performance

    • Margins

    • Market Size

    • Market Share


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