Dot.Com Bubble
R&D, Advertising and the Market Value of Internet Firms
By: Damir Tokic
Outline: 1. Introduction 2. Article Summary 3. Discussion 4. Conclusion
Introduction
During the Dot-com “bubble”, internet firms were highly valued compared to “old economy” firms. Internet firms’ stock prices were unrealistically high. Most of those firms were operating under loses and no tangible assets to warrant those prices. Analysts justified those prices and recommended buy ratings but later a crash followed.
Article Summary
This article explains the relationship between intangible assets (advertising and R&D) expenditures and internet firms’ market value during 1996-2000.The author presents two opinions in regard to internet stock’s valuation. The first theory is based on DCF methodology and asserts that due to poor earnings and low earnings visibility, internet stocks were irrationally overvalued in 1999. Secondly, based on the option pricing theory, it can be justified that the prices were warranted due to growth of those firms and volatility as primary value drivers. The article details five literature reviews on valuation – (1) Investment opportunity approach to valuation and more especially growth firms, (2) The life cycle theory, (3) The effects of intangible assets (R&D and advertisement) to market value, and (4) Valuation of internet firms using real options.
Based on the life cycle theory, as the firm grows and matures, managers have a tendency to pursue growth rather than stockholders’ welfare. Those with comparative advantage over the competition tend to invest more in the growth stage to expand their operations. Under this theory, the value of the firm is divided into: (1) option value of growth opportunity, (2) present value of cash flows from asset-in-place. This model is based on the idea that the firm’s life cycle determines its expected returns. Expected return attributable to each component of value largely depends on the growth
By: Damir Tokic
Outline: 1. Introduction 2. Article Summary 3. Discussion 4. Conclusion
Introduction
During the Dot-com “bubble”, internet firms were highly valued compared to “old economy” firms. Internet firms’ stock prices were unrealistically high. Most of those firms were operating under loses and no tangible assets to warrant those prices. Analysts justified those prices and recommended buy ratings but later a crash followed.
Article Summary
This article explains the relationship between intangible assets (advertising and R&D) expenditures and internet firms’ market value during 1996-2000.The author presents two opinions in regard to internet stock’s valuation. The first theory is based on DCF methodology and asserts that due to poor earnings and low earnings visibility, internet stocks were irrationally overvalued in 1999. Secondly, based on the option pricing theory, it can be justified that the prices were warranted due to growth of those firms and volatility as primary value drivers. The article details five literature reviews on valuation – (1) Investment opportunity approach to valuation and more especially growth firms, (2) The life cycle theory, (3) The effects of intangible assets (R&D and advertisement) to market value, and (4) Valuation of internet firms using real options.
Based on the life cycle theory, as the firm grows and matures, managers have a tendency to pursue growth rather than stockholders’ welfare. Those with comparative advantage over the competition tend to invest more in the growth stage to expand their operations. Under this theory, the value of the firm is divided into: (1) option value of growth opportunity, (2) present value of cash flows from asset-in-place. This model is based on the idea that the firm’s life cycle determines its expected returns. Expected return attributable to each component of value largely depends on the growth
References: Chan, L.K.C, Lakonishok, J., & Sougiannis, T., (2001). The Stock Market Valuation of Research and Development Expenditures. The Journal of Finance. 56(6), 2431-2456. doi 10.1111/0022-1082.00411. Palepu, K. G., Healy, P.M., (2008). Business Analysis & Valuation. Mason, Oh: South- Western Cengage Learning. Tokic, D., (2004). R&D Advertising and the Market Value of Internet Firms: Part 1. Journal of Internet Commerce. 3(2), 21-79