Profits, Losses and the Non-Linear Pricing of Internet Stocks

Abstract

This paper sheds light on the economics of Internet firms by extracting information on major value-drivers from their stock prices. Contrary to conventional Wall Street wisdom that there is little or no method in the pricing of Net stocks, I find that basic accounting data are highly value-relevant in a simple nonlinear manner. Using log-linear regression on quarterly data for 167 Net firms over the period 1997:Q1?1999:Q2, I show that Net firms' market values are linear and increasing in book equity, but concave and increasing (decreasing) in positive (negative) net income. When Net firms' earnings are decomposed into revenues and expenses, revenues are found to be weakly positively priced. In contrast, and consistent with the argument that very large marketing costs are intangible assets, not period expenses, Net firms' market values are reliably positive and concave in selling and marketing expenses when net income is negative, particularly during the first two fiscal quarters after the IPO. R&D expenditures are priced in a similarly concave manner, although more durably beyond the IPO than are marketing costs. The concavity in the pricing of core net income, R&D costs, and selling and marketing expenses runs counter to the notion that Net firms are expected to benefit from extraordinary profitability stemming from large strategic operating options, or increasing returns-to-scale.

JEL Classification: G12, G14, M41, M44