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The Coming Internet Depression?

Typically, on Monday's I answer reader mail. However, I'm devoting today's piece to many common questions in the past few weeks: What's happening to Internet stocks?

Simply put, Wall Street has become hypersensitive to any inkling of bad news. Unfortunately, with a slowing IPO market, higher interest rates, escalating energy prices, dot-com blow-ups and even signs of international turmoil, it is hard for companies to avoid bad news.

Of course, even the Internet blue chips have been obliterated. The most notable example is Priceline.com . As one analyst said, investors are "naming their price" for this stock. On Friday, the stock was at $5-9/16, which was a mere $926 million market cap. Less than a year ago, the stock was over $100 per share. In fact, the company has lost nearly 80% of its value since mid-September.

Interestingly enough, Prince Alwaleed bin Talal recently invested in Priceline.com, and has lost millions (oh, by the way, he has a large investment in Apple, too).

Then again, the Prince has a diversified portfolio - on the order of about $20 billion. In other words, when investing in high-tech (and especially Internet stocks), it is critical not to concentrate most or all of your assets in these investments.

But even the "big boys" have problems with this. Look at Bernie Ebbers, the CEO of WorldCom . This week, he had to sell 3 million shares so as to meet a margin call.

I think there is another important thing to consider when investing in Internet stocks: cutting your losses. I recommend that you place stop loss orders on your positions. In fact, I would suggest about 15 to 20 percent below the purchase price. A stop-loss is not full-proof, especially if the stock plunges more than 20%. But, experience has shown that a small, steady fall preceeds a major fall in a stock. Priceline.com is a key example.

With the markets anathema to surprises, I would not buy any stocks before their next earnings report. A case in point is Yahoo! , which will report its earnings tomorrow (after the close). On Friday, the company had a new 52-week low of $79-7/16. The stock was as high as $250-1/16.

Sure, the stock has fallen substantially already. And, the company is profitable and still growing fast. But its valuation of $44 billion still looks like a premium valuation. Adverse news could pound the stock and, unfortunately, lead to further declines with the Internet sector.

The fact is that Yahoo! relies heavily on online advertising revenues (about 80% of all revenues). With dot-coms running out of money, how is Yahoo! going to sustain its growth rate?

However, I'm not implying I'm a "doom and gloom" peddler. I'm extremely bullish on the Internet sector. There are tremendous values in the marketplace. In fact, I was happy to see BusinessWeek's cover story of the "coming Internet depression." Such front-covers are a good sign that the market is poised for upside. But, as always, it is still prudent to keep in mind the old values of investing: diversification, limiting losses and focusing on solid companies.