Internet Stocks With Little Institutional Ownership Could Be in for a Tough Ride

"It is far, far safer to be wrong with the majority than to be right alone."

So said economist John Kenneth Galbraith, and Net stocks are proving him right once again. That's because many Internet stocks that've found themselves standing without the support of institutional holders are starting to look a little queasy.

Institutions behave differently than individuals. They're still stupid. They're still greedy. They still follow the masses like lost sheep. But they are slower to make decisions, and they tend to stick where they're stuck -- with big holdings in stocks.

A $5 profit in a stock tends not to affect the performance of big funds. Big funds measure their holdings in the hundreds of millions of dollars, so they need to amass large chunks of stock to affect their results -- selling a little here and there doesn't help. They hold on. No bachelors here: They are not afraid of commitment.

This has started to show in the recent performance of Internet companies that went public during this year's IPO flood. iXL Enterprises (IIXL Quote) finished its first day up at 17 7/8 and, despite a successful IPO, sagged in succeeding days. But institutional buyers were able to use those dips as buying opportunities. Now the stock has more than doubled and, according to Market Guide, institutions own more than 15% of the company. Similarly, after its April 20 IPO, Proxicom (PXCM Quote) saw three or four serious sags, but institutions piled on to amass a 34% stake and now the stock is solidly in the black, up 422% since issuance.

Institutional Support
Stocks' performance with and without institutional backing
Stocks With Significant Institutional Ownership
Stock	Symbol	% Institutional Holdings	IPO price	Current Price	Performance Since IPO
Brocade	BRCD	12.3	19	221 1/8	1,064%
Media Metrix	MMXI	16.1	17	50	194%
Proxicom	PXCM	33.8	13	67 7/8	422%
iXL Enterprises	IIXL	15.4	12	36 7/8	207%
Stocks Without
Stock	Symbol	% Institutional Holdings	IPO price	Current Price	Performance Since IPO
FlashNet	FLAS	2.1	17	7 1/8	-58%
Intraware	ITRA	7.9	16	20	25%
Marimba	MRBA	8.8	20	30 5/8	53%
Prodigy Communications	PRGY	5.4	15	21 9/16	44%
Source: Market Guide, IPO Monitor.

"We went public on one of the worst days possible," says Stuart Wolff, CEO of Homestore.com (HOMS Quote). "But it worked in our benefit because institutions were able to acquire the positions they wanted." The figures aren't out yet, but Wolff says that Homestore.com's institutional ownership will prove to be strong. That may support the stock in the future. Shares of Homestore.com are up 87% since its IPO.

In the days before an initial public offering, of course, Internet CEOs must feel like celebrities. They're inundated with phone calls from financial institutions begging for larger allocations of stock. Everyone they ever played golf with suddenly wants in. Forget the "friends and family" shares; firms fight like hell to get bigger allocations of hot deals. But understand this: There are two types of institutional shareholders -- 1) holders and 2) flippers (picture the dolphin if you must).

Few on Wall Street will admit to being a flipper. Flippers get the stock at the IPO price and unload it as soon as it takes off, hoping to juice their long-term returns with quick profits. Good investment banks won't give shares to flippers; the I-bankers are trying to build a base of institutional shareholders that will hang with the stock, through thick and thin. But even well-intentioned fund managers find themselves flipping stock, even if they have to disguise the sale of the stock to the underwriter by selling it through another I-bank after the IPO.

"Sometimes I want to own a company," says the manager of a $1 billion-plus New York-based mutual fund. "But if it's a hot deal, the bankers spread it around the Street to all their clients. That doesn't help me because I need a lot. So if I can't buy it cheap in the aftermarket, I won't hold on to what I have. A 10,000-share holding won't affect my returns. But I have to keep taking the little deals to get the next one that comes along." So this manager continues to flip.

Daytrading is much ballyhooed, but according to the Electronic Trading Association there are only 45,000 full-time daytraders out there. The online trading industry may be overpopulated by more than 120 companies, but they are fighting for no more than 5 million accounts. Indeed, some industry experts say that when shareholders with multiple accounts are taken into effect, fewer than 3 million people have online trading accounts. That's peanuts when one considers that the Nasdaq Stock Market regularly does a billion shares daily.

Institutions still run Wall Street. Mutual funds, banks, corporate profit-sharing plans, insurance companies, labor union trust funds, pension funds ... this is the kind of massive money that supports upwards of 70% of trading in the major markets.

Even in small issues, individual investors can't support a weak stock price. Imagine a situation where investors become wary over shares of, say, CompanyX.com. If the share price takes a hit, an institution that still likes CompanyX.com will be there to add to its holdings. But individual traders bail. Stocks without institutional support can fall hard and fast. "One thousand shares at a time can send a stock price down in a hurry," says the manager of a San Francisco-based hedge fund. "These guys need us."

Problem is, once that stock has cratered, it has a hard time attracting institutions back. "It's up to businesses to prove to the institutional traders that they have a real business," says this manager. "Once the stock is toast, it makes that argument a little harder to swallow."

This also means that low-lying Internet stocks with a growing base of institutional owners could be poised to pounce. And, if this theory continues to hold tight, it means that highflying stocks that don't show institutional ownership could be in for a ride bumpier than the metaphors in this paragraph. But until then, it could be another roller-coaster ride.