Valuing Dot-Coms After the Fall, Timothy M. Koller

The dot-com bubble burst in 2000 was an inevitable fate that left the NASDAQ composite index in a slump. Investors were investing in dot-coms at “reckless” rates, but after the crash few investors could be persuaded to invest in this sector, and were even “scaling back their on-line initiatives.” Timothy Koller, author of “Valuing dot-coms after the fall,” ranks this burst as one of the most dramatic in loss of value in the market over the past 20 years. Koller believes that each bubble burst, such as the previous busts from biotech, real estate, among other fads, left investors looking for ways not to return to traditional notions of value creation, such as an emphasis on cash flow.

The author believes that investors should look at new ways for valuing dot-coms, not just abandon them. The internet is here to stay, and the sector does have value. Three basic principles can be applied to see the potential value of the internet and its various opportunities. The first principle is that “cash flow is king.” Solid investment strategy should look beyond metrics like price-to-earnings or multiples of revenue. This does not look at intangible assets that flow through income statements not the balance sheet. Koller recommends a long term discounted-cash-flow analysis that looks at the industry in a sustainable state or moderate growth. Then, use weighted scenarios based on the probability of future performance that takes into consideration all outcomes, from bankruptcy to high growth. This will give a full picture of how value is created by the company.

The second principle, “spotting the value creators,” analyses companies with no profit and negative cash flows. Value creation is not limited to the present, but the potential revenue and its ability to convert that revenue into future cash flow is measured by looking at long-term return on capital. An analysis of how the company will generate revenue, what will be their average return on capital, and how big the future...