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I didn't see Bruce's original appear on RT although he addressed it there.
-------- Original Message --------
Subject: Nasdaq Bubble... Something to consider
Date: Sun, 27 Feb 2000 14:37:16 -0500
From: "BruceB" <bruceb@xxxxxxxxxxxxx>
To: <dennis@xxxxxxxxxx>, <realtraders@xxxxxxxxxxxxxxx>
> This tech thing may be a bubble or it may really be a fundamental
> change. Art Cashin on CNBC compared it to the railroad stocks in the
> 1800s. They went from being insignificant to dominating the market and
> it lasted for many years.
>
I know most of us on the list primarily take a technical approach to
trading, but I'm surprised that more listers who think the Nasdaq is in a
bubble stage haven't at least seriously looked at whether things really are
different these days. Rather than just repeat the "new economy" slogan,
here's a couple of specific examples of how many companies today are turning
one of the longest held economic principles on its head.
Since the beginning of the industrial revolution, every company has had its
rate of growth limited by what is known as the law of diminishing marginal
returns. This principle basically states that a firm will produce its good
or service up to the point that the cost of producing the next unit of good
or service no longer gives it a competitive advantage in the marketplace. A
good international example of this is Honda and GM. On average, Honda cars
receive higher quality and value ratings than GM cars (although the gap is
shrinking).
So why doesn't Honda put GM out of business? Because there are only so many
good engineers, workers, and parts suppliers that Honda has access to to
make superior cars. Honda therefore, produces cars up to the point that the
last one made still has an competitive edge over GM cars. Because there is
a limit to the superior cars (on average) Honda can produce, there is plenty
of demand (in terms of quantity and car types and styles) that GM can fill.
This principle simply does not apply to many internet-based companies today.
A good example is YHOO. The growth of YHOO really has no marginal limits.
In order for YHOO to expand growth, all it has to do is add computer
processing and storage capacity (let's call this computer strength for
short). Computer strength is not only not constrained by the law of
diminishing marginal returns, but may actually work in reverse. As we all
know computer strength in terms of cost is continually dropping, which means
YHOO can add strength at the margin at a cost that may actually be LOWER
than the previous unit increment.
Another way that internet companies are turning diminishing returns in
reverse is in the marginal value added of an increasing customer base. If
all my neighbors go out and buy GM cars, there is no direct benefit to me
buying a GM car. They might be buying GM cars because of a good price,
which I will benefit from too, but the fact that THEY bought the same car
offers no distinct advantage.
The same cannot be said of companies like EBAY. The more customers EBAY
gets, the more people looking to sell something will use EBAY, because they
know there is a better chance that a higher price will be received for the
item being sold. In other words, if my neighbors start using EBAY, it is to
my economic advantage to use EBAY as well. Because of this effect, EBAY
might actually be able to RAISE the percentage of each sale it receives,
because the net benefit to the seller will still be higher than using
another site. The same could be said of AOL. If my neighbors are using AOL
chat rooms, I have an incentive to use AOL as well to get in on the
conversation.
This is just one example of how "new economy" companies are defying the
standard principles of economics. I'm not saying these stocks aren't
overvalued, I'm just saying to use the conventional methods of valuations in
coming to that decision is a big mistake.
Disclaimer- I don't own any of the companies mentioned (and I don't use
AOL...).
Bruce
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