Four student researchers--Stefano Siglienti, Tracy Tefertiller, John Wenstrup, and John Wood, all MBA Class of 1999--prepared a report on Internet valuation under the supervision of Ezra Zuckerman, assistant professor of strategic management. Based on interviews with securities analysts and Internet company executives, the study describes how Internet stocks are valued and details how analysts, retail investors, and the Internet companies themselves influence prices. "This report is one of the most systematic attempts to collect opinion from people closest to the action," says Wenstrup. The study concludes that, for now, Internet stock prices are better explained by supply and demand than by long-term value.

Analysts play a pivotal role in valuation. A favorable report can have a significant impact on a stock's price. Analysts can also sway a company's choice of bank for its initial public offering. Young Internet companies look for a bank with a top-notch analyst who will defend the company's game plan after the IPO. They want an analyst with a reputation that will help sell the stock to institutional investors whose long-term holdings are much more stable than those of fickle day-traders or retail investors.

As online trading has taken off, retail investors are becoming more influential, in some cases owning up to half of an Internet company's float (stock not controlled by the firm). "This is one of the first times a wide base of retail investors, rather than institutional investors, has had a huge say in what happens to the stock price day to day," says Wenstrup. "As a result, achieving brand-name awareness and reaching growth milestones is very important." Some individuals may trade on inaccurate information they see in chat rooms, which has created frustration among Internet executives who have been trying to communicate through traditional methods. Executives told the researchers they plan to spend more time and effort trying to reach this growing group of investors.

Clearly, valuation methods for Internet stocks are in the early development phase. Although analysts publish conventional measures, such as price-earnings ratios, and less common standards, such as per-user statistics, none of these seem to matter much when the company is months or years away from profitability. Analysts and companies agree that current measures are more useful for contrasting differences among stocks than for developing meaningful valuations. One early gauge of success--how many hits a Web page gets--is considered an irrelevant measure these days. A few analysts are trying to set new quantifiable standards: among them, lifetime value per user (a subscription measure borrowed from the cable television industry) and revenue growth versus previous period marketing expense. Companies, on the other hand, continue to use an avalanche of press releases touting their latest benchmarks to attract investors.

Even gaining consensus on the definition of an Internet company has been difficult. Some analysts distinguish between Net-extended or hybrid companies--those using the Internet as an added distribution channel for an existing business--and Net-centric companies, which are built exclusively on the Internet and usually have little or no inventory. Analysts have a hard time explaining why pure-play Internet issues enjoy huge stock values and hybrids often do not. Some analysts have merged coverage of certain hybrids with that of offline analysts who cover the same industries, such as retail or media. Yet others predict the Internet label may be gone in five years as the line between offline and online companies within a particular business continues to blur.

For now, shortages of stock are driving much of the rise in Internet stock prices. Until better measures of performance can be developed, the market is very much at the mercy of supply, demand, and the whims of retail investors. Says Siglienti: "If you want to strike gold, you'd better bet on several companies and be prepared for most to disappoint you." --Barbara Buell

"Internet Valuations: Surveying the Landscape," Stefano Siglienti, Tracy Tefertiller, John Wenstrup, John Wood (under the supervision of Ezra W. Zuckerman), GSB Technical Report #82, January 1999