Twelve years ago, a total of $5 trillion in market value was lost when the "Dot-com" bubble burst. Many investors lost their life savings, their kid's college funds, or their retirements as a result.
Flash-forward to today, and I'm convinced many investors are running the risk of making the same mistake that caused those trillions of dollars in losses a decade ago.
Let me explain...
You've undoubtedly heard about the new multi-billion dollar "Web 2.0" companies like Groupon, Zynga, LinkedIn and Facebook. The mainstream financial press can't get enough of them...
For the past several months, investors have been blindly throwing money at these companies.
Take Zynga for example. Zynga is up 25% since it started trading back in December... but the company doesn't even turn a profit.
In fact, Zynga has lost $400 million during the past year. The firm's net loss came out to $1.40 per share... or more than 10% of its current share price.
LinkedIn (Nasdaq: LNKD), a social-networking site for professionals, is up slightly since going public. But it's been a wild ride. The stock trades at a P/E over 800.
Groupon (Nasdaq: GRPN) doesn't even have a price-to-earnings (P/E) ratio... because it has no earnings. In the past year, the company has lost $350 million or $0.97 per share.
Facebook -- considered to be the "hottest" of all these companies -- hasn't gone public yet. At this point, we can only guess what sort of enormous valuation it might see. Estimates are calling for a valuation of $100 billion. With net income of $1 billion in 2011, that means the stock could sell for 100 times earnings.
And not only do these stocks trade at ludicrous valuations, but they are tremendously volatile. Zynga dropped 18% in a single day after announcing earnings in February. Groupon dropped 14% after announcing disappointing earnings just a few days earlier.
Yet despite these ridiculous fundamentals, some investors still say these are attractive investments.
To me, that's a big mistake.
Don't get me wrong, I'm not saying companies like LinkedIn and Facebook are going to go bankrupt. On the contrary -- these businesses have high margins, which may one day help them become attractive investments.
But to me, it's clear that at these prices, the new "Internet Bubble" is one of the most dangerous places for your money right now. Buying these stocks is like buying a lottery ticket. Maybe they hit it big... but more than likely, I think these stocks will lose money.
But here's the thing, you don't need to roll the dice on a company like Facebook if you want to make money in the stock market.
See, I've been investing actively for two decades, and during that time I've learned a lot of valuable lessons. The single most important one is this...
The best way to get wealthy in stocks is by owning companies that dominate their markets, are essential to our way of life, and that continually reward their shareholders with cash.
Take a company like Intel (Nasdaq: INTC) for example. Unlike risky Web 2.0 companies like Zynga and Groupon, if Intel and its products disappeared tomorrow, then our day-to-day lives would grind to a halt.
What's more, Intel is a dominant company dedicated to making its investors rich... not some grossly valued Internet company that is essentially the same as buying a lottery ticket. Intel has also made a lasting commitment to making you -- the investor -- wealthier by buying back stock and paying dividends.
In the past five years, the company has paid more than $16 billion in dividends, and bought back close to $27 billion of its own stock. And not only has the company raised the dividend every year during that time, it's also increased distributions by 87% in the process.
All of these moves make the stock more valuable, even if earnings don't rise a cent. And that's clearly showing up in the stock price. In the past 12 months, Intel has returned more than 42%.
Of course, nothing is 100% certain in investing. Maybe one day, some, if not all of the "Web 2.0" companies could become attractive investments.
But given the performance of Intel... its rising dividends... billions in share buybacks... and the dominance in its market, I see it as just more proof that stocks like Intel are how you become wealthy in the stock market.
Action to Take --> If you want to keep investing "where the action is," there's nothing to stop you. But if you're investing in stocks trading at 800 times earnings that pay no dividends, then I think you're not investing... you're gambling.
And gambling is not how you become wealthy in the stock market.
[Note: This article is an excerpt from my most recent report "Forget Facebook... Buy This Instead." In this report, I provide more on the sort of stocks I think investors should buy -- including several names and ticker symbols -- instead of grossly overvalued Internet stocks. My "buy" list includes one company holding more than $135 per share in cash (and it's not Apple). To read more about these stocks, visit this link.]
-- Paul Tracy