Making The Most from Internet Stocks

published 8 June 2006

Right now, there's reckoned to be anything up to $3 trillion currently held in cash by investment funds, including hedge funds - most of which have a crying need to perform better against conventional funds.

Wealthy individuals across the world are looking for an asset class with exceptional growth potential. And more and more of these wealthy individuals are based in tech savvy India and China.

These two booming economies house a burgeoning middle class of over 500 million people. These are people who will be increasingly looking to invest if not directly themselves in stocks then via contractual savings schemes and investment funds. These are the entrepreneurs, technologists or investors who will power new technological developments - and investing - into the next decade.

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In fact, there's already a joke in Silicon Valley that the tech industry there is driven by 'IC's...but they don't mean 'integrated circuits'. They mean Indians and Chinese!

Since 1990, 30% of all Valley start-ups have been formed and driven by Indians and Chinese investors, reaching some $20bn in aggregate sales and creating 70,000 jobs. Moreover, they are a rising power in the 'venture capital' community. Vinod Khosla of Kleiner Perkins is widely regarded as the Valley's most influential venture capitalist. Given that there are now at least 20,000 Indian tech millionaires in the US, there is a rich source of tech savvy funding to keep the momentum up.

What is being nurtured now is a rich network of 'ICs' moving to and fro between the US and their Indian and Chinese bases, with funds and talent available to develop technology companies whether in the US or the homelands.

Many, having 'made it' in the US, are creating companies in their own countries. Some increasingly influential quarters believe that the US economy has passed its meridian while the Asian economies are 'future filled', with far superior growth prospects. The ICs, perhaps more than any other group, understand something very important: that digital technology is not just one sector among others, because it invades and conquers almost every other market.

Think of the way it has reframed automobiles, consumer appliances, games, toys, publishing, audio/visual media, machine tools, electric motors...you name it.

Take a look at the 'computer' inside a cell phone, for example. The digital signal processor shows the impact of Moore's law. This states that computers get smaller and faster and double in power every 18 months. It's held true with remarkable accuracy since it was put forward by Gordon Moore, co-founder of Intel, in 1965.

Only a few years ago, mobile phones were the size of bricks. Now they fit in your pocket. And thanks to the continuing operation of Moore's law, they are now becoming fully-fledged 'teleputers' - devices the size of your hand capable of what desktop computers could do only a few years ago.

But there's another wholesale shift underway. Corporations are moving from their old internal server structures to wireless internal networks. Wireless technology is also creating a wholesale shift from value PCs to laptops and then to hand-helds. So Moore's Law in the raw is now less important than the price/performance per watt.

Moore's Law was still very much the power behind the last great Tech Wave - the Internet bubble of 1995 to 2000. That boom and bust scenario, however, was nothing like the South Sea Bubble or Tulip Mania of the 17th century, as some commentators have suggested, despite the high drama and 'irrational exuberance' involved.

And it bears little relation to the phase we're now entering.

Sure, things got messy for the tech sector in 2000 and 2001. But meanwhile, the internet was being steadily constructed and expanded, driving huge and largely beneficial changes in business and private life for 400- 500 million people - despite Enron and Global Crossing, online porn, cyberfraud and viruses.

And at the same time as the City finally began to label dotcom stocks 'toxic', the worldwide web began to show adaptive qualities through The point is this - that the chasm between the financial world and the real world was, and remains, as wide as ever. And the tech beat - the real world - goes on. It doesn't pay heed to bull and bear markets. The geeks on the edge, who get their rocks off doing interesting work and impressing their peer groups, carry on regardless with their 'disruptive' activities during the worst of the stock market's down times.

A great example is Linux. It came to the fore just as billions of dollars were being lost by over-exuberant tech investors worldwide. Linux had the Microsoft honchos spitting blood for a time. But despite growing up in what was at the time considered a doomed sector, Linux has now become the standard in many important government IT circles, including the Chinese in Beijing.

Linux has eaten into Microsoft's market share in the PC server market as well. And it's bitten a big chunk out of HP and SUN's shares of the proprietary UNIX markets. Now these companies are accepting Linux as a phenomenon they have to embrace, rather than try to throttle.

And what about Amazon? While over 200 dot.com companies were going bankrupt, and a huge amount of wealth went up in flames, the great internet 'disrupter' - itself often forecast to go belly up - went from strength to strength. Likewise eBay, which is creating an alternative global economy, and sports a stock price over double what it was at its 2000 peak.

Remember the Google IPO last year? Wall Street tried to undermine it, but the float was a stupendous success immediately giving Google a bigger market capitalisation than the Ford Motor Company and the stock has gone on soaring ever since.

And which pundit forecast in January 2004 that Apple's stock price would better than double during the year? Apple was still being classed as a PC company, a rather bizarre one at that, which you held for entertainment value as much as anything else. But Apple is not a PC company. It's a brilliant developer and user of computer technology, including internet technology, to turn on high-spending consumers.

The startling success of iPod, which is an internet connected disc drive wearing hot pants, is a case in point. Steve Jobs now hopes that the iPod 'halo effect' will lead to increased Mac sales. The circle will keep on spinning with an iPhone likely to join in soon.

In short, internet stocks have actually been some of the very best investments around since 2000. Those that survived the bust are hardly struggling laggards.

They are harbingers of the future - a future where the worldwide web will become a true nurturing medium of communities and affinity groups. These 'network effects' lie at the heart of the success of Google, with its page-ranking algorithm, as well as eBay - with its alternative global economy - and Amazon with its volunteered book reviews.

Of course, there's every chance we'll see the same kind of dot.com hysteria take hold as what I call the 'Wireless Revolution' matures and peaks by 2015 or thereabouts. But well before then, there are going to be some outstanding profit opportunities for sensible investors.

Hundreds of billions will be made and lost in the stock market. Hundreds of companies will come and go. But that's the lifeblood of 'disruptive investing'. It's simply the way of human nature to create such devastating booms and busts.

By Michael Ormfor The Daily Reckoning

Editor's Note: Formerly 'Mr Bearbull' at the Investors Chronicle, Michael Orme has sat across the table from Bill Gates and the founders of Intel on more than one occasion. He's worked at the cutting edge of technology for 30 years, as an analyst, stockbroker, writer and hands-on consultant to start-up ventures and major corporations alike.

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