Flying the Koop

April 11, 2000

Dear Investor,

In a climate where the market can swoon over 570 points in a Nasdaq second and then retrace its ground just as fast, there is no doubt that risk management should be the primary goal. At least, for any investor wishing to preserve capital and ensure long-term success.

Extraordinarily volatile markets are nothing new, nor are they bad. In fact, they are the very stuff that promote liquidity, punish speculators, and return value to stock prices. In the Nasdaq boomerang just past, many margined investors were sold out of securities or wiped out clean, with margin calls running five times their usual volume. This is nothing but healthy for long-term fundamental investors who buy real companies, not ephemeral stock prices.

One concept all but lost in the massive technology bull market is that buying a stock means buying an equity stake in an underlying company. Buying an equity stake in an underlying company and having success with that investment means that such a company must have a realistic way of making money at some point.

Witness the tragedy of DrKoop.com (Koop), one of the first internet companies that appears to have run aground against this simple truth. Koop was once trading at over $45 per share, valuing the company at somewhere upward of $1.35 billion. As of Friday, the stock had declined to $3, forcing investors at the peak to lose 93% of their money and assessing the company at $112 million. Why the plunge? For the very good reason that its auditor, PricewaterhouseCoopers, declared that the company would soon run dry of cash and probably not survive as a going concern. It turns out that many internet companies like Koop never really had a way to generate revenue and feed their terrible burn rates. Anyone applying a little common sense would have seen a company built on the odd name of a former surgeon general and an internet prayer, but not much else. It is our opinion that the Koop story, which broke the week before the Nasdaq collapse, had more to do with subsequent investor jitters than the Microsoft saga (which is, after all, company-specific news beneficial to competitors such as Sun, AOL, and others).

What’s instructive about Koop is that the story was known ahead of time. According to Business Week, PricewaterhouseCoopers gave the same bleak analysis at the time of the firm’s IPO. The story of Koop is a story of daytraders buying into stocks purely as gambling chips with no regard for corporate fundamentals. Daytraders saw Koop climbing and thus piled on, ignoring warnings and caring only that the stock showed dizzying upward momentum. After all, if a stock goes from 2 to 20 and you are a daytrader, you don’t care if the company’s really worth 20, you just delude yourself into thinking that you will be able to get out before the bottom drops. Unfortunately, as many traders learned with Koop, when an illiquid stock is sinking like a stone, you can’t sell at any decent price.

This is why investors who wish to manage risk and preserve capital should not gamble with their assets but instead subject investments to rigid quantitative and qualitative screens that make sure the company is not just worth buying—but worth holding, hopefully (if you’re doing it right) forever. This is the only risk-management strategy that works time in and time out, for the long term and promotes eventual, albeit sometimes slow, success. In fact, an investment is akin to a marriage, in the sense that your mate should be a good match for life, while a trade is like an affair where your partner can become a disaster unless you get rid of them when you want to—a big if.

We would like to take the opportunity to profile how our main technology-sector manager goes about buying stocks so that you understand how much work, research and risk-management enters the process. The manager of the Seligman Communication & Information Fund, Paul Wick, has the best audited ten-year annualized return of any manager in the diversified tech sector. While there are many managers who have beaten him in any given year, no one has beaten him over the ten-year, long-term time period which truly separates the boys from the men.

Paul Wick, assisted by his specialized team of analysts, subjects every stock purchase to exhaustive due diligence. This means that every company undergoes the following: balance sheet analysis, earnings projections analysis, management evaluation, competitor evaluation, sector evaluation, supply chain evaluation. Perhaps most important, the capitalization strategy of each company is thoroughly analyzed to determine whether the company is well-financed or will have to return to the capital markets within a short time, thus devastating current shareholders. Mr. Wick and his associates closely follow the sector in which each company operates to understand whether that company will be the ultimate winner. And finally, he looks to identify the next Microsoft or Intel, not a company like Koop, but rather one with a unique strategic advantage, proprietary technology and a reasonably well-capitalized structure to last it through bear markets. To that end, the Seligman Fund has approximately 3% in venture-capital type start-up companies that have been keenly evaluated and screened for their future prospects.

For example, Mr. Wick identified Microsoft and Intel early on, long before they were darlings of Wall Street. He bought them many years ago after applying cogent, detailed analysis and knowledge of the revolutionary software and chip markets. His fund investors have benefited dramatically by owning them ever since. They remain in the fund to this day. Instead of being stuffed in the portfolio and forgotten about, each is reevaluated on a continuous basis, a never-ending process that includes regular visits with high-level management and balance sheet reviews. It is through such technique that Paul Wick has bought and held the Intels and not the Koops. And intends to continue doing so.

A final word: please don’t fear market turbulence. The long-term investor is the ultimate beneficiary of such chaos, and operates somewhat like the “house” in a casino: collecting the chips from the gamblers as they have their expensive idea of fun.