Why the City likes Internet nonsense

Philip Collinsreveals how a firm that never makes a penny can be worth more than Sainsbury's

It is sadly true that investment managers, as a rule, do not read Wittgenstein. Perhaps they should abandon the Investor's Chronicle for the Tractatus. Perhaps they might then be inclined to pass over in silence that about which they can only speak nonsense. I refer to the Internet, where investors can be persuaded to part with other people's money for any two-bob company with the words "dot" and "com" somewhere in the prospectus.

On Monday 26 July Freeserve, Britain's first major Internet company, was quoted on the stock market. Eleven million shares were traded in the first half-hour of the flotation. In little more than two hours, 107 million Freeserve shares changed hands, amounting to 10 per cent of the whole day's transactions. Freeserve rose 36 per cent, from an opening price of £1.50 per share to £2.05 per share, and the 153 million shares available could have been sold 30 times over. It seems almost rude to interrupt the stampede to point out that Freeserve hasn't yet made a single penny in profit.

The rush for Internet stocks is theological. It rests on a faith that the technology will, in due and unspecified course, produce profits that will make the Luddites wince at the memory of their caution. It is no more sophisticated, really, than saying that the Internet looks quite likely to catch on. The US technology stocks have led the Dow Jones and been credited with a revolution in productivity. Investors are frightened into improvidence by the idea that they might miss a native UK version.

So it is beside the point that Freeserve doesn't actually make any money. As far as people in financial markets are concerned, profit registered today is immediately dealt with. It is, in a neat dual meaning, discounted. Last year's reported profits are described by analysts as historic, as though the interim report from Booker's cash and carry operations can rank with Churchill's war speeches. It is tomorrow's profit that counts when one is trying to assign value to a company's stock. So Amazon.com, which has yet to register its first profit, can be capitalised at a higher value than Sainsbury's, which does a nice line in groceries.

Yet there's the rub. We know from year to year roughly how much money Sainsbury's will make. But anyone who predicts the profits of Freeserve five years from now is just a very brave guesser. Most people assigning values to Internet companies are trying to sell you something. The calculation of a stock price depends on at least three years of predicted earnings, which are then discounted back, adjusting for risk, to a net present value. It is not as difficult as it sounds (although if anyone ever tries to convince you it is interesting, strike them off the Christmas card list at once).

When a company is still loss-making, like Freeserve, these calculations are more than usually worthless. In the week before flotation, Freeserve was valued by experts at between 60p and 230p per share. Every expert has good reasons for their conclusions, and all but one of them is a lunatic.

The subtlest wisdom produces the subtlest folly. At the close of business on Monday, Freeserve was already worth more than £2 billion. The whole of the rest of Dixons, which owns 80 per cent of Freeserve, is valued on the market at £3.8 billion. Dixons has hundreds of retail outlets. A person can walk into Dixons and purchase electrical goods. Dixons is indisputably there. It makes money, which is set out beside glossy pictures of Sir Stanley Kalms in its annual report and accounts. Yet its Internet afterthought, created only last September, is already worth half as much as one of the most famous names on the high street.

It may yet transpire that a few thousand Freeserve shares is the best investment ever made. The point is that nothing sensible can yet be said. So plenty of nonsense must be said. There is the same number of hours in every day, and stockbroking salesmen and -women have to say something.

At the moment investors are taking an unspecified bet on the Internet. In due course this will come to seem like saying one enjoys authors. But which authors? Just authors. It may be that Freeserve, a delivery system, is passed over in favour of a company that supplies content, just as people prefer books to printing presses. Indeed there are some signs that quality of content is what will count in future. The BBC site, for example, has more visitors than any other in the UK, because everyone in the country has heard of the BBC.

As in all technological revolutions, investment in the Internet will produce some fantastic winners and many losers. For the moment it is hard to say which side Freeserve will be on. The investors have voted with their fear.

But, as Auden warned them, "the promise is only a promise,/ the fabulous country impartially far".

Strategists are charged with analysing the unanalysable. They take refuge in complexity, for fear of admitting that nothing can be said. Erudite nonsense is rather easy, as a matter of fact. Alan Greenspan, the US Federal Reserve chairman, once gave the City a marvellous motto for times of inexplicable change: "If I have made myself clear, then you must have misunderstood me."

The writer, a former economist in the City, is now senior research fellow, Social Market Foundation

This article appears in the 02 August 1999 issue of the New Statesman, America says: never again!