Personal Finance - Sky-high Net shares come down to earth.

Internet shares have been the investment phenomenon of the past three months in the UK – and of the last 12 months in the US. Huge gains at the end of last year were followed by dramatic falls in the first week of this year. Stockbrokers on both sides of the Atlantic have been under virtual siege as thousands of individual investors clamoured to buy and sell their hot tips. The surge of interest in Net companies has left stock market commentators struggling to find new ways to define what is a rational investment. Even after falls last week, investors seem hell-bent on putting their cash behind anything with a ‘.com’ in the name. Traditional methods of valuing shares have been thrown out of the window in the dash for stock. Shares in UK Internet gateway Freeserve, for example, were trading last Friday at 300 times the company’s annual revenue. Wildly overpriced, by conventional valuations. Companies which are making no profits at all command premium share prices. Figures compiled last week (and therefore already hopelessly out of date) put a global market value on Internet companies of $528bn. But they have total annual sales of only $34bn and, though some are profitable, aggregate annual losses of $7bn. The move to Internet shares is driven as much by institutions as by private investors. They sense a sea change in the way the world does business and want to grab a slice of the action before it is too late. They are stumping up staggering quantities of venture capital to help new Net firms get started. Everyone is looking for the kid-next-door whose newly floated shares will turn into the next Microsoft and make you rich beyond your wildest dreams. Gloom-mongers predict that this dash for cash will end in tears. They claim Net-hype is persuading people to pay silly money for shares in companies, some of which are little more than a business plan and a promise. As ever, the truth lies somewhere between these two extremes. Undoubtedly, a few Net companies will go on to become global giants. But investors will have to kiss many frogs to find their prince. There are a lot of ‘me too’ companies; Net retailers, Net access providers and would-be online banks who have little to distinguish them from the competition. These ‘pure’ Net stocks carry the highest risks but the potential for the highest rewards. Potentially a safer bet are the companies who sit behind the Net; those building computer servers, Networks, or mobile phone chips and writing the software that makes it all tick. No matter which sites are visited, these firms will gain from continuing growth in Internet traffic. A third option is to invest in longer established businesses which have an exposure to the Internet. Prudential and WH Smith, for example, both saw their share prices rocket last year when investors started to rate their attempts to build an online business. Even if these companies’ Net ambitions are unsuccessful, at least shareholders have the fall-back of a conventional business generating conventional profits, backed by bricks-and-mortar property assets. Whichever class of Net share you go for, the sector is proving to be volatile with share prices swinging wildly. Shareholders have to be prepared for a bumpy ride and be willing to hold onto stock through dramatic falls. One of the reasons for such volatility is that most of the Net pioneers are small companies, with limited stock out on the market. Stock shortage can drive prices up rapidly when it is in demand, and a shortage of buyers can pull it down again when sentiment turns. These rapid price movements in turn impact on the bigger firms. While it may be fun to speculate a few hundred pounds on the Net punt of your choice, most investors are still uncomfortable betting their pension on the Internet. For bigger sums, unit trusts and investment trusts allow investors to spread their money across 50 or even 100 different companies and between different nations. This is lower risk than buying one or two individual stocks, though the gains will be also be lower than if you are lucky enough to invest in a share which turns into an Internet giant. Investors can opt for a pure Internet fund, such as Framlington’s Net Net unit trust, which launched last year. Alternatively, a more broadly based technology fund such as Aberdeen Asset Management’s technology unit trust – a star performer for almost two decades – tempers exposure to Net shares with investments in other emerging technologies. Another option is to follow one of London’s new technology indices, the TechMark 100 and the TechMark All Share. Set up by the Stock Exchange in November as London’s version of the US Nasdaq index, TechMark is an easy way for technology companies to get their shares listed on the London market. Existing technology names such as ARM Holdings, Sage and Psion are also included in TechMark. Close Fund Management has set up two index tracking unit trusts which follow the fortunes of TechMark. The TechMark-100 index is already up more than 50% since its launch. Such investments may not be as much fun as picking the next Microsoft, but they have a better chance of making at least a modest fortune over the first decade of the new century. – Stephen Womack is a reporter with Financial Mail on Sunday.