At 38, Ryan Jacob has spent a long decade investing in tech stocks and gaining a reputation as someone able to endure some of the market's heaviest gyrations with a certain sense of calm. A minor celebrity before the tech bust, Jacob posted triple-digit gains at his old fund, Kinetics Internet. Then in 1999, he launched his own Jacob Internet Fund and promptly watched it slump mightily in the bust that followed.
In the intervening years, Jacob has retained his appetite for risk while posting some very respectable results. As of March 5, his fund boasts a hefty five-year annualized return of 24.4 percent, according to Morningstar, which rates it four out of five stars. This year, however, the fund is off about 17 percent after ending lower in 2007. As the technology sector continues to weaken amid broad market weakness and the threat of a recession, Jacob is currently touting a more restrained approach, reining in some investments on highflying Chinese tech shares plus names like Google that he thinks could have further to fall. Jacobs spoke with U.S. News. Excerpts:
Is there more risk of tech-sector weakness in the near term?
I think, generally speaking, expectations have to come down another notch. They're still too high. That's why we lowered our weighting in some of the larger-cap tech names where we think there could be some number cuts over the next three quarters. Could these problems work their way through by the end of this year? It's fifty-fifty at this point. In the tech sector, it's very dangerous to get in front of names where there could be some significant lowering of the bar. How do you approach that?
You have to have a sober, realistic viewpoint as to where we are in the economy today. We're more inclined to add to positions of companies that may be weaker due to other issues but where expectations have already been lowered so much that there's less risk. It doesn't mean there aren't good opportunities. We think we'll see an increased level of merger and acquisition activity in the tech sector. Tech won't be hurt nearly as much by problems in the credit markets in terms of buyouts because many tech companies are sitting on a lot of cash. Who are you cutting back on?
Google. We cut back Apple recently, but then added a little back. Generally, some of these larger names. Even though stock prices are down, expectations could still be too high. I'm fairly confident Google will get to $1,000 a share, probably in the next two years. However, in the meantime it could go considerably lower. It's still a position for us, but we've lowered our weightings to reflect that higher risk. What are you adding?
Companies that have secular growth trends that could do well in a slowing economy and companies where expectations are lower: Shutterfly: It's an online photo-sharing service that after the recent declines is trading around seven to eight times cash flow and growing more than 40 percent a year. So why is it down so much? Competitors are lowering prices on prints, which are about a third of revenue. But two thirds of the business comes from selling things like mugs, calendars, or mouse pads—a very high-margin business that's become a larger percentage of the overall pie. They have good viral marketing characteristics and a sticky customer base. Once you start using an online photo-sharing site, you're not likely to switch. They will be affected by consumer spending, but the secular growth will be strong enough to offset that weakness.
Earthlink is one of our special-situation value plays we have sprinkled in the fund. It's the old dial-up Internet service provider business. They went through a management change last year and got serious about focusing on the core business. They got rid of Wi-Fi and other initiatives that were burning though a ton of cash. They laid off about 40 percent of their workforce. You're not going to find many companies trading at about three times cash flow. As long as the decay in the [dial-up] business is minor—which it has been—the cash flow will stay relatively stable. As long as it does for the next three to four years, it's a great investment based on price.