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Where there’s smoke there’s fire:
Making sense of the NASDAQ’s future
by Adam Lass
Remember “irrational exuberance”?
Alan Greenspan’s now famous characterization of the 1999 and 2000 market bubble has now been inverted — into 2001’s equally irrational despondence.
And yes, a boatload of dot-coms have gone up in smoke. Of course, most were nothing but smoke to begin with, and anyone with an ounce of common sense knew it. But that doesn’t mean high tech is dead... even if it doesn’t smell that good right now.
But over the next decade, the remaining high-tech players — those with real, useful technologies and a fighting chance at making a profit — really will transform the world. Into what, I have no clue, but no neo-Luddite wishful thinking can undo the changes already underway.
So the question at hand is not “Will there be a recovery?”
Rather, it’s “When will it start?”
And how can you make truckloads of cash off it?
To get a better feeling for the timing of inevitable market currents, I recommend the thoughts of an obscure 12th-century mathematician, Leonardo da Pisa, aka Fibonacci.
Best known for introducing Arabic numerals to Western Europe, Fibonacci was also the creator of the Fibonacci sequence, a number series that accurately predicts a wide range of natural phenomena such as the pattern of branches on trees, petals on flowers, the spirals of a nautilus shell and the retinal patterns of the human eye.
Fibonacci-based analysis is equally revealing when applied to the stock market. It shows that the period following any market boom will exhibit a predictable series of pivotal support and resistance points based on a line from the rally’s lowest trough to its highest peak.
The falling knife’s final target
As noted on the accompanying chart, these Fibonacci points clearly identify all of the NASDAQ’s significant turning points in the bear market that followed the 90-week boom from 10/9/98 to 3/10/00 — including May 2000’s bottoms at the Fibonacci 50% mark and the double-top failure of July and September 2000 at the 23.6% mark.
Fibonacci analysis even predicted this January’s failed rally at the 61.8% mark, and the subsequent hideous plunge that followed. More significantly, it also forecasts a likely end to the bloodshed with the 100% mark at 1357.
By that point, the NASDAQ will have peeled away 74% of its value — if you accept that value as genuine. (I don’t). But it leaves intact the solid incremental gains of the previous decade. And the survivors of the last few months of carnage are tan, fit and primed for another ten-year growth cycle.
With a bull market in sight, the issue is no longer “when to buy” but “what to buy.” Using my proprietary CXS computer screening system, I’ve isolated a single stock that will take off regardless of which high-tech sector leads the rebound. Let’s make no mistake about it. This is a highly speculative investment. But one that has a substantial upside. Just bear with me for a moment...
Harris & Harris Group, Inc. (HHGP:NASDAQ) is a venture capital investment firm that has the majority of its assets in start-up companies.
Wait. It gets even worse.
These start-ups tend to be small, thinly capitalized, unproven companies hanging everything on risky technologies. These pie-in-the-sky companies frequently lack management depth. Most have never generated a nickel in profits.
Back to exuberance?
I know what you’re thinking right now. HHGP is exactly the sort of company that I wouldn’t have touched with a ten-foot pole a year ago — when it was at its high of US$35.
But now that it’s available for a mere two bucks and change, HHGP’s broad portfolio of potential rockets deserves a second look.
Incorporated in August 1981, HHGP has invested a substantial portion of its assets in companies at the private development or start-up stages. Usually, Harris owns all of the stock of a start-up for a substantial period, and likes to get heavily involved in recruiting management, formulating operating strategies, product development, marketing and advertising, assisting with financial plans, and establishing corporate goals for these fledgling companies.
Harris also assists in raising additional capital for its babies from other investors, introduces these companies to potential joint-venture partners, suppliers, and customers, and helps them establish relationships with investment bankers and other professionals.
As a venture company emerges from the developmental stage with greater management depth and experience, and launches into the public arena via IPO or is sold outright to larger companies, Harris expects its role in the company’s operations to taper off.
Enough jargon for a moment
Here’s what that means: Harris buys companies with good ideas but no cash or biz smarts. They set them up with some cash to get moving, guide them through the maze of bankers, lawyers, accountants and government bureaucrats. Then they sell them for major green (and maybe keep a chunk of stock for their own portfolios).
Take a look at a list of Harris’s current nestlings. I will gladly concede that some of these are totally out to lunch. But that’s OK, for a number of reasons I’ll get to in a moment:
- essential.com, inc.:
resells services and commodities like long distance phone service, Internet access, electricity, natural gas, propane, heating oil and satellite TV.
- Experion Systems, Inc.:
provides e-business selling platforms that enable manufacturers and service providers to replicate a retail selling experience on their websites.
- Exponential Business Development Company:
more venture capital (talk about wheels within wheels...).
- Genomica Corporation:
a leading pharmacogenomics software company. Their tools combine epidemiology, genetics, molecular biology, biochemistry and clinical applications into a single software environment that enables scientists to accelerate genetic discoveries and pharmacogenomics. This one’s about to go IPO.
- Informio, Inc.:
enables dot-coms to extend their Internet presence to 1.5 billion telephones.
- Kana Communications, Inc.:
more incomprehensible e-biz.
- Kriton Medical, Inc.:
sitting on a hot new medical device.
- MedLogic Global Corporation:
wound closure devices (high-tech band aids).
- Nanophase Technologies Corporation:
patented and proprietary nanocrystalline technology.
- NeuroMetrix, Inc.:
provides physicians with immediate and cost-effective information to aid in the diagnosis of common neuromuscular conditions, including repetitive stress injuries, diabetic and toxic neuropathies, and low back pain.
- Questech Corporation:
makes cool new-era construction materials.
- Schwoo, Inc.:
really esoteric computer security. (Schwoo? Weren’t they those edible creatures in Li’l Abner?)
Clearly, some of these companies — perhaps even most of them — are going nowhere fast.
That’s okay, because Harris’s VC business model doesn’t depend on across-the-board success. It just needs one or two winners a year to push the value of HHGP up tenfold.
Darn close to free money
And there’s another interesting twist to the story. Harris is sitting on a good-sized chunk of cash, which it occasionally invests in fast-moving junk bonds and the like. And they usually do all right at it. In fact, as of last December, Harris’s net asset value per share (NAV) was US$3.51, compared to a current stock price of US$2.25. Let’s look at that number for a moment.
After the nominal market value of the company’s discounted publicly held securities (closing year-end stock prices multiplied by number of shares) was reduced from US$11,263,256 to US$9,702,547, to reflect appropriate “haircuts” or discounts, the company’s gross assets totaled US$43,343,423. Reserves totaling US$11,509,948 for taxes, employee profit-sharing and other liabilities reduced net assets to US$31,833,475, for a NAV of US$3.51.
The upshot is that even without a major VC success, HHGP’s stock is undervalued by 56%. In many ways, HHGP is clearly riskier than I would have tolerated in the final phase of the previous growth cycle. Price to sales is an outrageous 49.79, forty times higher than what I usually look for. But its cash position is healthy, management is crafty, and shares are dirt-cheap.
Buy Harris & Harris Group, Inc. (HHGP) under US$2.50, with a six-month target of US$5 and a -25% trailing stop.
Adam Lass is co-editor and technical analyst of Options Underground, an options trading service.
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