The Dryden Press: Finance: Brigham

ISBN: 0-03-028931-9

Chapter 9 Stocks and Their Valuation

AOL Takes Investors On An Exciting Roller Coaster Ride

A $10,000 investment in America Online (AOL) when it went public in 1992 would have grown to $10 million by November 1999! However, AOL's road to riches has been anything but smooth - its stockholders have had an exciting and often nerve-wracking roller coaster ride.
Let's just see how rough that roller coaster ride has been. Suppose you got started late, but were still shrewd enough to buy $10,000 of AOL stock in December 1998. One month later, in January 1999, your investment would have nearly doubled, and by early April it would have been worth $44,000! However, two weeks later, you would have been down to $28,000. The stock rose again in May. A series of sharp ups and downs followed, and your investment would have been worth only $21,500 in mid-September. Nonetheless, if you stayed the course for another two months, your investment would have once again surged beyond $40,000. Today, AOL's investors are unsure of whether the stock's long-run trend will be up or down, but if history is any guide, the movement will be swift, uneven, and large.
By virtually any measure, the stock market has performed extraordinarily well in recent years. From slightly less than 4000 in early 1995, the Dow surged past 11000 in 1999. To put this remarkable 7000-point rise in perspective, consider that the Dow first reached 1000 in 1965, then took another 22 years to hit 2000, then four more years to reach 3000, and another four to get to 4000 (in 1995). Then, in just five years, it topped 11000. Thus, in the last five years investors' have made almost twice as much in the stock market as they made in the previous 70 years!
The bull market has made it possible for many people to take early retirement, buy expensive homes, and afford large expenditures such as college tuition. Encouraged by this performance, more and more investors are flocking to the market, and today more than 79 million Americans own stock. Moreover, a rising stock market makes it easier and cheaper for corporations to raise equity capital, which facilitates continued economic growth.
Some observers are concerned that many investors do not realize just how risky the stock market is. There is no guarantee that the market will continue to rise, and even in bull markets some stocks crash and burn. Federal Reserve Board Chairman Alan Greenspan made the comment that investors may be pushing stock prices up due to "irrational exuberance." If he is right, the market could take a huge tumble.
Note too that while all boats may rise with the tide, the same does not hold for the stock market – regardless of the trend, some individual stocks make huge gains while others suffer substantial losses. For example, in the first 11 months of 1999, Qualcomm's stock rose from $25 to more than $400, but during this same period Fruit of the Loom lost nearly 90 percent of its value.
While it is difficult to predict prices, we are not completely in the dark when it comes to valuing stocks. After studying this chapter, you should have a reasonably good understanding of the factors that influence stock prices. With that knowledge – and a little luck – you may be able to find the next AOL or Qualcomm, and avoid being victimized by "irrational exuberance."

DISCUSSION QUESTIONS

Do you think that the investment boom described in the vignette was a result of "irrational exuberance", as suggested by Alan Greenspan?
What affect do you expect these large stock market booms to have on the future of investing? In other words, would you expect small, normal, or large stock returns over the next ten or fifteen years?

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