STREET SENSE: The fundamentals of stock market investing
Why the Dot-Com Bubble Burst
A new technology isn't always an investment opportunity. Consider the importance of the "barrier to entry" concept.

What would it take to duplicate the assets of ExxonMobil or to start a company that produces jetliners? Probably hundreds of billions of dollars -- if it were even possible. Yet only a year ago, investors were willing to put higher values on totally unproven Internet stocks than on ExxonMobil or Boeing.

The rise of the "dot-com" stocks was a classic "bubble" that had to end in disaster. The bubble burst last year. But the warning signs were there all along.

If you intend to win in the stock market, you need to understand the concept of "barriers to entry." Simply put, it means that the more difficult it is for competitors to enter a specific marketplace, the easier it is for companies already in that industry to prosper over the long term. On the other hand, when it's easy for new competitors to gain access to a market, no one in the industry makes much of a profit.

THEY KNOW THEIR COMPETITION

ExxonMobil and Boeing may have their good years and not-so-good years, but anyone thinking of starting a new company to compete with them faces formidable obstacles. In reality, the barriers to entry in the oil and jetliner industries are virtually insurmountable. ExxonMobil knows exactly what companies it will be competing with now and in the future, and Boeing realizes it will have to duke it out with Airbus for every important airplane order. But wouldn't everyone in business like to have only a single competitor?

Contrast that with the Internet and the sector known as "e-tailing."

Barriers to entry in e-tailing are virtually non-existent. Amazon.com is the most recognized name in marketing consumer products over the Internet, but everyone from Barnes & Noble to a housewife selling homemade jewelry on a Web site competes with them. So where's Amazon's competitive advantage? In truth, it doesn't have any advantage.

Wall Street analysts, who almost without exception grossly overrated the prospects of Amazon and other e-tailers, talked a lot about so-called "first mover" advantage. They argued that the first company to get into a particular segment of e-tailing on a large scale and build a "brand" would be able to attract a loyal customer base. But there's no evidence of that in Amazon's numbers.

ILLUSTRATION: NICK ROTONDO

FIRST MOVER, FIRST LOSER

At least three publicly owned companies tried to gain "first mover" advantage in selling pet supplies over the Internet. They spent so much money on marketing and brand-building that they all struggled financially. Remember the great little sock-puppet dog in the Pets.com commercials? Well, he's gone; the company's closed its doors; and the money of the shareholders who believed in the concept is also gone.

"B TO B" DISAPPOINTS INVESTORS

Another group of Internet stocks supposed to hold even greater promise than the e-tailers were the "business-to-business" companies. The "B to B" entities set out to establish convenient online marketplaces for large companies that purchase things like chemicals and paper in big dollar amounts. The goal was to collect a commission on each transaction they facilitated online.

But with few barriers to entry in "B to B," large companies set up their own online marketplaces. And when that happened, the B to B stocks plunged.

Before you invest in a stock in any fast-growing industry, ask yourself this question. How easy is it going to be for other competitors to get into this industry? And if the answer is "too easy," it's time to look elsewhere.

Ophthalmology Management Associate Editor Jerry Helzner has written more than 50 articles on stock investing for Barron's. He has been a regular stock market columnist for other business publications and was a member of the equity research department of a major regional brokerage firm.