Do profits matter? It's a fine line to walk between generating profits and growing.

April 21, 2000 8:15 AM PDT

Patience-to-Earnings ratio wears thin for dot-coms
By Tiffany Kary
Staff Writer, CNET News


.With the Nasdaq well below its March 10 high of 5,048, investors are finally asking what the 'E' in the P/E, or price-to-earnings ratio, means.

Although profits suddenly mean something to dot-com investors, some analysts and executives maintain Net companies still need leeway to build out their businesses.

Do profits matter?

The profit tug-of-war will determine the direction of Net stocks for the foreseeable future, said investment experts. The tug-of-war is already underway -- shares of Excite@Home (Nasdaq: ATHM) fell Thursday after the company said it was foregoing near-term profits for long-term market share. The usually optimistic Merrill Lynch analyst Henry Blodget said he didn't 'see any positive catalysts for the stock.'

And in recent weeks, companies with no roadmap to earnings suffered the most (see chart). Shares of companies like CDNow (Nasdaq: CDNW), DrKoop.com (Nasdaq: KOOP) and Webvan (Nasdaq: WBVN) have been decimated.

As investors shun promising ideas for real results, dot-coms will have to generate cash instead of running back to the market for a quick-fix stock offering. To determine the long-term winners, investors will have to scrutinize business models and look for balance between growth and profitability.

Growth vs. profit

It's a fine line to walk between generating profits and growing. Excite@Home was panned by some analysts because it chose international expansion over immediate profits. The problem? Excite@Home has been profitable and has a track record. The market is more forgiving with promising newcomers.

'Companies that have been around for a while should have profits, but newcomers should be allowed time to build market share,' said Abhishek Gami, analyst for William Blair & Co.

Gami said he would allow business-to-consumer e-commerce companies about 12 to 18 months to become profitable. In the business-to-business space, a company should have as much as two to three years to turn a profit. In B2B, there are only a handful of competitors and a lot of market share to grab. With a portal, he wouldn't look at anything that didn't plan on earnings within 12 to 18 months.

About.com (Nasdaq: BOUT), which is far below its 52-week high of 105 13/16, is caught in the middle.

'Investors are looking at the total market, not individual companies,' said About.com CEO Scott Kurnit. 'They are looking at stock charts, and bringing the company down to at least 50 percent below its 52-week high, without regard for when the company reached its peak, or why.'

Kurnit is hoping a path to profits and strong third and fourth quarters will give About.com a boost. But his company is still in danger: Kurnit said About.com won’t be profitable for another 20 months.

The profit club

About.com is on the outside looking into a club that includes Yahoo! Inc. (Nasdaq: YHOO), eBay (Nasdaq: EBAY), America Online (NYSE: AOL), RealNetworks (Nasdaq: RNWK), Lycos (Nasdaq: LCOS) and Go2Net (Nasdaq: GNET). Inktomi (Nasdaq: INKT) and CNet (Nasdaq: CNET) are the latest members to the profitable dot-com club.

'The end game is, everyone will ask about profitability for every Net stock,' said Go2Net president John Keister. 'In 1997, people were talking about investing in earnings multiples for 2000, and now its 2002. People keep pushing it out.

'Smart investors, and institutional investors may not be satisfied with this anymore. Everyone has to trade on a multiple of earnings and revenue growth,' said Keister.

Leadership counts too

Leadership also counts for a lot. Chuck Hill, director of research at earnings tracking firm First Call, noted that profitable companies such as Yahoo, Go2Net, RealNetworks, AOL and Lycos have held up better than others, but said it doesn't have much to do with earnings. Hill said those companies are seen as industry leaders, which will survive. 'Even these companies are selling at multiples that are questionable,' he added.

'When a new company comes along, it's valued as a concept. Then there's a correction, and those that survive go on to be a good growth stock,' Hill said.



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