e-mail Paul Lewis on paul@paullewis.co.uk
Forget September 11th. Forget the crooks at Enron. Forget dotcom mania. The reason the price of shares is as low as it was six years ago is because during the 1990s investors not only took their eye off the ball, they forgot the rules of the game.
I used to do a morning business programme on Radio 5 Live. In March 2000 a listener e-mailed an urgent message "Help. I don’t want to miss out on all the free money". He wanted to know how to apply for shares in lastminute.com – the latest in a long line of new companies which intended to do business over the internet. The shares cost £3.80 each and 189,000 individuals bought the maximum of 35; most wanted ten times as many. They hoped to sell them at a profit, doubling their money overnight. But by the time they were allowed to sell, the share price was £3.20 – and falling. Shares in lastminute bottomed out at less than 19p in October 2001.
Would those eager investors wanting free money have invested if they had been told in March 2000 ‘Psst. Lend us a hundred and thirty three quid. We won’t pay any interest in the foreseeable future and if you want your money back you may get less than you put in (maybe as little as £6.56 in November 2001). But in the long-term we may make you some money’. The answer is ‘Yes’. They would and they did. All the information about the hopes and plans of lastminute.com was in its prospectus and it did not promise instant wealth – indeed it said it would not make a profit until 2004. But people still invested because they believed, like my listener, they would get free money as the share price rose. Shares are now 85p. But lastminute has done a lot better than many other internet companies. It still exists, has cut its losses to £4 million in the second quarter of 2002, and says it is on track to make real profits soon. Meanwhile, many of its contemporaries have gone bust, leaving thousands out of work and shareholders with nothing.
It was not just naïve individual investors who went mad in 1999 and 2000. Many banks and investment funds – even the Queen – bought into dotcom companies and lost money. Perhaps the most spectacular UK casualty was Marconi. Previously known as GEC, run by Lord Weinstock, it was the bedrock of any investment, the bluest of blue-chip shares, profitable and with, the company says, £1 billion in the bank though others put the figure at £2 billion or more. But in 1996 new managers took over. They sold off the successful electrical, engineering and avionics divisions and spent the cash and more on becoming a "global communications and information technology company". They bought technology companies for £3 billion more than they were worth. By August this year the cash in the bank had become a debt of £4 billion. In a deal to stave off bankruptcy, shareholders lost more than 99% of their money.
This madness happened because the long boom years of the 1990s led many, perhaps most, people to lose sight of what companies are for and what shares are. Companies are there to make a profit. If they do not do that, they will eventually disappear. A business also needs ‘cashflow’ – money coming in and going out, like the blood flowing round our bodies.
A shareholder lends a company money and in return owns a small fraction of the company. Shareholders hope for a return on their money. Traditionally that has been through a dividend, a share in the profits paid each year to every shareholder. But during the stockmarket boom of the nineties people looked for another sort of return. They did not care about dividends, they wanted to see the ‘value’ of their shares rise. As the boom took off many made money in this way. So instead of the essentials of profits and cashflow, the share price became the god everyone worshipped. If someone else would pay more for it, then that was its value, even if the other person was a fool. Dotcom companies became very valuable even though most made losses rather than profits and the only way cash flowed was out the door.
Dotcom mania is not new. In the 17th century it was black tulips – just before the price collapsed in February 1637, four bulbs could buy a canalside house in Amsterdam. In September 1720, shares in the South Sea Trading Company, which never traded but seemed a one-way bet to wealth, became valueless overnight as the bubble burst. In November 1857 the collapse of the Royal British Bank was just one of many that century where people lost fortunes on shares in mines or railways that never came to anything. In the 1920s many individual investors thought the price of shares could only go up – leading to the great Wall Street crash of October 1929. The 1990s boom was just another example – and dotcom mania the final expression of believing in the value of something that produced nothing.
Now we must pick up the pieces. Restore confidence in companies. Re-learn the essentials of profits and cashflow. Remember that a share is no more nor less than a loan – and like any loan, we should be clear before we part with our money that the debt will be repaid and will earn interest until it is. And of course remind ourselves of rule number one – there is no free money.
Winter issue - December 2002
e-mail Paul Lewis on paul@paullewis.co.uk