Mixed signals for small investors in cyberspace

Investors in the Internet are soaring today into a "New Era" of hypergrowth, slack inflation, and robust productivity - all powered by new technology.

It is a change of epoch proportions and means the US economy, and stock markets, will avoid a severe downturn while creating wealth.

So goes the reasoning of some economists as the Dow Jones Industrial Average flirts with 10000 and Internet stocks, along with many other glittering shares, trade at record-high valuations.

"Stay bullish," says Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc. in Chicago. "The data continue to show exceptional growth with no inflation - clear evidence of a New Era," he says.

But some analysts believe investors - especially those committed to the Internet - are not sailing beyond traditional economic gravity toward weightless wealth. Instead, investors are frantically flapping like Icarus, soaring too close to the sun.

"The sector looks pretty pricey," says Lawrence York, manager of the WWW Internet Fund in Louisville, Ky. "Many Internet stocks are way ahead of themselves and there is plenty of room for them to correct back."

Internet skeptics point to disturbing facts that bring Internet boosters down to earth:

First, although the vast majority of Internet firms have yet to make a dime, their stock valuations far exceed all but the most extreme estimates of cyberspace growth. Even profitable online leaders pose staggering price-to-earnings ratios while exploding to numbing market values: America Online is bigger than General Motors; Yahoo! is bigger than Boeing.

Second, the comparatively scant number of shares traded in most Internet companies will intensify a drop in prices, just as it has exaggerated their ascent. When going public, many online firms sell only a small portion of their total shares, often less than 20 percent. Company executives and original investors retain the majority.

Day-traders, or investors who trade through online brokers, seize on this "thin float," often with trades of just a few hundred shares. For many companies, the entire tally of publicly available shares often changes hands in just a matter of days.

During normal trading, the meager supply and rapid-fire trades can provoke dizzying volatility. During panic selling, there are no shares to cushion a sudden flight. Prices could crash.

"Big institutions cashing in on all the hype and hysteria over Internet stocks at some point will pull out their money to solidify their gains," says Brett Miller, analyst of computer technology resellers and distribution at A.G. Edwards in St. Louis.

"Those always left holding the bag are the small investors," he says.

Huge company losses and thin-ice markets have yet to chasten the common investor. Internet company "insiders," though, apparently see the writing on the wall.

Executives and first generation investors have sold unusual amounts of Internet shares since October. For example, insiders at Amazon.com have sold 1.3 million shares; those at America Online, 2 million, according to First Call Investment.

Granted, insiders often sell for reasons unrelated to company performance. "Insider selling is a bit of a concern," says Paul Cook, manager of the Munder NetNet fund. "But you've got to frame it with the fact that these managers have significant portions of their portfolios in their companies."

Still, a sell-off by many insiders often becomes a reliable indicator of a major correction, or at least a sign of slowing earnings growth, say analysts.