Pride goeth before destruction and a haughty spirit before a fall. - Proverbs 16:18

The new century marks a momentous occasion for King Investment Advisors. We enter our twentieth year of service. For senior members of the firm, this year marks the start of the fourth decade of wrestling with the bulls and the bears. The entire investment world ends a decade that makes the roaring twenties look like a slow dance. Financial markets have created wealth exceeding the forecasts of all but the most Pollyannaish. And a growing legion of soothsayers insists, "This time it's different, it's a new era." But is it really? Do the old rules of investing no longer apply?

Even in this new age of Pax Americana and technological development, we respectfully demur.

Profit, Always

Market enthusiasts correctly emphasize the recent, sweeping impact of technological innovations. For governments, businesses, and consumers alike, the nature and style of economic activity have been revolutionized. Pervasive global telecommunications have helped introduce technological innovation in economies around the world at seemingly warp speed. Running parallel to whirlwind economic growth are the financial markets that appear, on the surface at least, to have found Jacob's ladder to heaven.

We at KING do marvel at the abundance of wealth and prosperity that has been created in recent years and sometimes instantaneously with the launch of the latest Internet IPO. We also think that these days a large number of people delude themselves into thinking they are investors as opposed to speculators or, dare we say, gamblers. We congratulate them on their good fortune and observe that many of them have made a lot of money for all the wrong reasons.

One should never confuse genius with a bull market. And one should never underestimate the capacity of markets to levitate on the twin dynamics of speculation and greed. A gargantuan growth in the U.S. money supply has produced a liquidity that has spilled over into a feeding-frenzy demand for nearly all stocks that are even remotely associated with technology or the mutual funds that invest in them. Wise investors will not lose their grounding amid the giddiness.

Two events that unfolded in the closing weeks of 1999 reaffirm some constants of economics and investing. First, Ebeneezer Scrooge visited a 130-year player in the old economic order, Fruit of the Loom. This manufacturer of undergarments and other apparel, whose logo is a cornucopia of fruit, finally poured out one too many lemons and filed for bankruptcy. Like other players from the shoe and apparel industry, it joined a long list of household names that have disappeared when their markets were captured by foreign competitors. Market globalization and the concomitant flight of capital have accelerated capitalism's creative destruction of unprofitable companies.

Equal opportunist that he is, Ebeneezer also crashed the new economic order. Value America, the online and home-shopping retailer whose revenues appear to be in inverse proportion to advertising expenditures, recently announced plans to slash its work force nearly in half and reduce its product offerings. Not surprisingly, Value America also forecast a fourth-quarter loss that is much wider than previously anticipated. Its stock, which saw its zenith at $74.25 a share last April, descended into the netherworld below $5 a share, slicing 35% off its value the week of the announcement. In the face of exponential growth in Net usage, and at the height of the holiday season, the culling of the minnows appears to have begun. All this seems a harbinger of ill fortune for all Internet wannabes siphoning money from the market trough.

Fruit of the Loom and Value America demonstrate that, no matter the decade or century in which we might think the world is created anew, the end game of economic activity is profits, always. Old industries such as shoes and apparel, textiles, and steel must compete in a global market. Despite the blessings flowing from the laws of comparative advantage, international trade will continue to weed out inefficient companies. The advent of the Internet will only hasten this never-ending process. At some point, the exploding number of starts and "reinvented" companies - almost all seeming to vie for wealth from telecommunications, technology, and the Internet - must convince even the most euphoric of investors that they can generate the lifeblood of capitalism, i.e., real cash flow. Else, as appears to be the case with Value America, investors will abandon ship. Unfortunately, hosts of investors, hedge funds, mutual funds, and day-trading addicts eventually will discover that, as with the Titanic, there will not be enough lifeboats to go around. When the fateful moment arrives for companies unable to deliver on the wildest of expectations, the real question for investors will be, "To whom do I sell?"

The Long Race

Much current stock market activity resembles the classic game of musical chairs. Everyone counts on finding a seat when the music stops. A more appropriate analogy is the greater fool theory. In many cases investors seem to buy stocks, not because of expected earnings, cash flow, or dividends, but because the stocks will go higher and then can be sold to an even greater fool. As long as there are enough fools to join the party, why not join in the fun.

A review of past manias should be instructive to those gorging on the recent liquidity feast. In the U.S. over the last 150 years, a number of transforming industrial and technological changes have had a profound influence on economic activity. Undoubtedly the Internet will rival or surpass many of these in long-range impact. Earlier examples of watershed developments include transcontinental railroads, electric power, telephones, automobiles, radio, television, airplanes and jet engines, early mainframe computers, transistors, and microchips. But among these industrial developments that indeed changed the world, the surviving corporations were few and the losers were many. In recent decades, flights of fancy have parted many a dreamer from his capital. For investors, the electronics boom of the early sixties, the Nifty Fifty stocks of the early 1970s, and the biotechnology mania of the early 1980s have strong parallels to today's technology stocks and Internet stocks in particular. When the promise of super profits from these businesses failed to materialize, their stocks wilted. They all had ignored an immutable law of investing: A stock is worth only the present value of the cash flows it is able to generate for its owner.

The Old Becomes New

No one should discount the ability of the old economy to adjust to the new one, as well as benefit from it. Many industries and companies may seem mundane to hordes of investors enamored only with growth and valuations that rival or surpass past speculative excesses. Nevertheless, old-economy companies will provide rewarding opportunities for those who may be understandably satisfied with simply achieving real rates of return with some level of certainty. After all, someone has to design the goods, make them, store them, and deliver them. Someone has to finance them; someone has to insure them; someone has to keep the tangibles of this world in circulation.

Before all the thoroughbreds of the old economy are relegated to pasture, consider the possibilities of their reincarnation. Recent anecdotal evidence suggests that many old-line businesses, including retailers, are adapting quite readily to the new economy of the Internet. To the surprise of much conventional wisdom and to the dismay of newly launched ventures, many Internet consumers still are more comfortable with names they know. After a recent survey of Internet usage and promotional expenditures, The New York Times reported that "Despite the tens of billions of dollars in venture capital invested to start whateveryoucanthinkof.com, almost none of these new Internet companies appeared to get any traction this Christmas, despite their outsized advertising spending. Rather, it was the Internet affiliates of well-known store chains - especially Toys "R" Us, KB Toys, J.C.Penney and the Gap - that surged toward the top of the ratings."

So while the decade-end surge in technology stocks is a vote of confidence in the future of the Internet and nearly all things related to it, it is not a revocation of the laws of economic gravity. At some point, either individually or en masse, investors will grow increasingly disenchanted with the failure of many of today's technology darlings to deliver the goods, i.e., profits. Indeed, it may well be that the rocky markets in the first few days of the new year have revealed a crack in tech investors' solidarity.

This lack of substance reminds me of being a young boy on one glorious Fourth of July evening when my older brother and I shot off roman candles. The candles' blazing balls of fire rocketed upward and then slowly descended as their colors faded. The next morning I went to find the "balls" left after the pyrotechnics. My brother laughed and told me there was nothing there; they had burned out as they fell to the ground. For a long time I didn't believe him, although later he and I laughed about that day many times. Like roman candles, many of today's stock market marvels are breathtaking to behold. But they, too, will burn themselves out and come crashing to earth. Slow-to-learn investors will find it all too real, and far from laughable.

The Last Laugh?

As anxious as we are about certain segments of the markets, we are cautiously optimistic about the long-term outlook for domestic and global economies and a large number of less-exploited securities. The benefits of an expanding global economy in the face of relative international calm are truly exciting. As the fruits of technology spread beyond their immediate beneficiaries, all economic groups will change, often dramatically. They will change the way they learn, communicate, and do their business. In this kind of new world, we think there are and will be many opportunities for investors to achieve good rates of return over the next several years. At least as much as technology itself, industries as diverse as finance, transportation, communications, entertainment, and healthcare will benefit from the revolutionary changes unfolding around the globe.

One key to capitalizing on these opportunities is to remember that stock investing - as distinguished from "playing the market" - is a proxy for buying a company. If you own a company, you have a claim on its productive assets, its ability to generate products, services, and sales, and, most importantly, its capacity to generate cash. If a company has little prospect of generating cash earnings in the foreseeable or even distant future, or lacks a distinctive franchise that would enable an acquirer to realize shareholder value from its assets, then to purchase its stock is to bet on the greater fool theory. As important as a company's capacity to generate cash flow is its ability to do so based on a durable comparative advantage.

Warren Buffet, a preeminent investor during the last several decades, is one of the most successful advocates of the concept of durable comparative advantage. Yet Buffet's long string of successes came up short in 1999. The stock of his flagship company, Berkshire Hathaway, declined almost 20%. A recent issue of BARRON'S details criticisms leveled at Buffett, including his lack of exposure to technology and the drag on his portfolio from slower growing businesses. Yet Berkshire's 24% compound growth rate in profits over three decades was no fluke. Buffett's pride in his collection of, in his words, "a marvelous collection of businesses" underscores the bedrock of his past and, in all likelihood, future success. Buffett fully intends to build on this philosophy of buying companies and not playing the market or chasing hype, and he cautions his shareholders to expect "only" a 15% annual increase in earnings and intrinsic value. We think many Internet companies will be able only to dream of 15% earnings growth on such a sizable base.

While Buffet was raked over the coals, Jeffrey Bezos, the peripatetic chairman of Amazon.com, found himself on the cover of TIME magazine as the Person of the Year. At the end of 1999, Berkshire Hathaway, which had reported annual earnings (probably understated) of $211 billion, had a market capitalization of $75.3 billion. At the same time, Amazon.com, with total annual revenues of approximately $1.6 billion and no profits (and correspondingly understated losses), had a market capitalization of $24.5 billion. Scotty, beam me up! Ere we bury Warren too soon, even though he is a young 70, we should ask ourselves a question. What does this strange divergence of valuation tell us, not only about investors' present willingness to place enormous bets on an emerging company, however promising its future, but also about the general psychology of investors who seem oblivious to the fundamental purpose of investing. The fundamental purpose of investing is to own a piece of a successful business that has a reasonably foreseeable stream of earnings or a claim on assets that can be monetized. It is very possible that Bezos and Amazon will survive and eventually make a profit. But the odds are much higher that Buffett, or someone of a kindred spirit, will do a far better job in providing a return on invested capital for years to come than someone losing money on every sale while trying to make it up on volume. When Bezos' "secret formula" for success comes under closer scrutiny - and this scrutiny has accelerated in the face of recently announced and escalating losses - Buffett probably will have the last laugh and a lot more money.

The year ahead promises to be challenging and also full of opportunity. We will continue to focus on finding value for our clients and enhancing their wealth and well being. By adhering to our Business Valuation Approach, about which we have chronicled so much, we believe we can continue to provide solid, long-term performance and service.

Best wishes to our clients, friends, and supporters for a healthy and prosperous new year.