John Plender ponders on the brave new world that the Internet industries proffer
As the silly season approaches it is time to marvel at the stock market’s capacity to invent new and exciting versions of the Indian rope trick. This week we learned that Dixons will launch its Internet subsidiary Freeserve at an initial market capitalisation of £1.3bn-£1.5bn. This was below the expected £1.9bn. Yet Freeserve is intangible to the point of being pure ether. Independent forecasters estimate the company’s potential losses next year at anything from £1m to £22m. Its worth is anyone’s guess.
Is this readiness to pay a fortune for such elusive value an unprecedented phenomenon? Not at all. History is strewn with manias and bubbles. And as bubbles go, the Internet boom is a great deal less daft than the Dutch tulip mania of the 17th century. Nor are Internet stocks the only investments in the market where people are happy to forgo current income. At the other end of the fashion spectrum is gold, which continues to plunge in value as disillusioned central bankers unload their official gold reserves.
Gold offers no income at all, and after allowing for custody costs its yield is negative. Those who bought in the inflationary panic in the second half of the 1970s at more than $800 an ounce are among the least happy investors on earth. No wonder nobody wants real assets nowadays. While Internet stocks have scarcely any assets to speak of, they do at least have customers from which the shareholders hope ultimately to derive large revenues. The big question is whether buying market share will prove a formula for a genuinely sustainable revenue stream.
Survival of the fittest
Some of these hi-tech stocks will fall by the wayside. A handful will show stellar growth. That is the nature of new industries. They start with a plethora of producers and then, to the extent that there are economies of scale to be reaped, they go through a process of consolidation. Just think of the countless marques that used to exist in the motor industry. We are now down to a handful of giant vehicle producers.
If there is a crazy feature of the Internet boom, it lies more in the exaggerated claims that are made for the technology. We are assured by the industry leaders that the Internet will change our lives and transform the world economy.
Yet the curious thing about technological innovation in the 1990s is how little it has done to change our lives so far. We already had computers in the 1960s and 1970s. The microchips under the car bonnet or in the home simply increase the efficiency of products that were invented decades ago. And if you compare the rate of technological innovation today with the rate in the late 19th century and before the first world war, it is less than exciting.
Then you had huge advances in the steelmaking process, great leaps in chemical innovation, the discovery of electricity, the transformation of sea transport, the introduction of refrigeration, the invention of the telephone, the beginnings of motorised transport and aircraft development.
Associated benefits
Of course we cannot foresee all the uses to which the Internet may be put. But it might just prove to be one of the less exciting technologies in terms of the supporting infrastructure it generates. Cars, after all, spawned roads, filling stations, out-of-town shopping and much else besides.
But let us take the optimists’ case about the Internet and assume that there really is a new paradigm. Even the most enthusiastic economists do not expect a resulting improvement in productivity of much more than 0.5-0.75% a year. Can you convince yourself that such an uplift in annual corporate earnings can justify the stellar stock market performance since the mid-1990s?
Against that background, investors’ expectations of continuing sky-high equity returns seem unrealistic. With the S&P 500 index on a trailing price/earnings ratio of nearly 44 and a dividend yield of just over 1%, I would bet that buyers of the S&P 500 at today’s levels will show only a single figure annual total return over the next 10 years.
In Britain equity valuations are less heady, but still stretched with the all-share index on a historic p/e ratio under 30 and a yield of over 2%. So I would still make a similar bet on single-figure returns in the UK on a 10-year view. Part of the justification lies in history. Analysis of long-run comparative data on investment shows that a majority of the total equity return since 1900 has come from reinvested dividend income, not capital growth. So when earnings and dividend yields have fallen as low as they have today, the handicap suffered by equities in the investment race is huge.
That is one reason why property stands a good chance of outperforming equities on a 10-year view in both the US and UK. The smoke and mirrors quotient is less than the Internet and the starting yield reassuring.
