As shares of Aether Systems bound higher, thoughts turn to yesterday's painful lessons

January 11, 2004|By JAY HANCOCK

THANK goodness for the investment lessons of the 1990s. We may be dreamers, but we're not dumb.

Once a generation, the stock market delivers a painful, indelible reprimand about the dangers of speculation and the importance of business fundamentals.

We learn that profits, dividends and diversification matter. We learn that advice-wielding brothers-in-law aren't Warren Buffett. We learn that the promise of technology stocks is not the same as the promise of technology.

We learn to be skeptical of little companies such as, say, Aether Systems Inc. of Owings Mills, which has never made money and whose business of mobile computer applications is extremely competitive.

Fool us once, Mr. Stock Market, but never again.

Aether's stock, of course, is up 70 percent since early last year. And many other small, profitless, speculative issues have performed even more amazingly.

What was that about business fundamentals?

"Speculation in individual stocks is driving the marketplace" at the moment, says Bob Smith, manager of the T. Rowe Price Growth Stock Fund. "We thought it would be up, but we didn't think it would be this strong."

To many Wall Street analysts, 2003 was 1999 with better airport security.

Dividends? Boring.

Earnings? For sissies.

The technology-heavy, earnings-light Nasdaq stock index popped by 50 percent last year - twice as much as the stodgier Dow Jones industrial and Standard & Poor's 500 benchmarks.

Richard Cripps, Legg Mason's chief market strategist, figures that 70 percent of the money that gushed into stock mutual funds last year got invested in small and medium-size companies - which account for less than 25 percent of the stock market.

And money going into stocks was huge. Inflow for all stock funds last year, as measured by the Investment Company Institute, will probably surpass $150 billion, annihilating the $27 billion outflow in 2002 when the market hit bottom.

By some measures, small stocks are as pricey as they were at the top of the bubble.

"The P/E ratio for the small- and mid-cap sector as measured by Value Line," Cripps says, "is now as high as it was in March 2000."

The price-to-earnings ratio - the stock price divided by earnings per share - measures how much investors pay for a stream of corporate profits, and March 2000 marked the beginning of the 2 1/2 -year stock collapse. Last year should have been the year of the dividend.

Congress cut the tax on dividends, which are portions of profits companies pay to shareholders. Dividends were seen as proof that corporate earnings were real instead of accounting figments. Dividends returned capital to investors instead of leaving it in the hands of shifty executives.

Dividend-paying stocks were going to regain the respect and luster of the 1950s and produce huge gains.

Actually, they flopped. Not only did they trail the small-cap zoomers; they trailed wider benchmarks, too.

Did we learn nothing? Are we idiots? Should we dive into small-company tech stocks for 2004?

Almost to a person, sages such as Cripps and Smith say no. They are confident - well, hopeful - that investors will recover from postwar giddiness and remember the basics of securities analysis.

Analysts believe 2003 was a classic post-slump spurt, in which stocks that do worst in a bear market seem to do best in a new rally. And they think the momentum will shift.

They're not pessimistic about stocks generally. The economy seems to be improving, and so are corporate earnings. They suspect stocks have more mileage in them, at least through the first half of the year. They just think safer, larger, more-solvent companies will regain the leadership.

There is a broad consensus on Wall Street that money will start to come out of small and mid-size stocks and flow into larger issues. Based on the price paid for expected future earnings, the biggest companies on the market right now are just about the cheapest.

As a result, brokerages recommend quality: blue-chip shares with solid earnings histories and generous dividends.

Of course, that's what they recommended a year ago. And the Federal Reserve's Alan Greenspan, who has flooded the country with dollars, isn't exactly discouraging people from speculating on whatever they want to speculate on.

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