Wednesday 8 March was relegation day for Imperial Tobacco, Whitbread and Thames Water. These three bastions of UK commerce, along with seven others, were given notice to leave the London Stock Exchange's Premiership - the FTSE 100 list of the biggest businesses.
The 10 promoted had something in common: all were involved in the so-called new economy. Two, Celltech and Nycomed Amersham, deal in biotechnology and pharmaceuticals, but seven of the others are technology-focused. These include Baltimore Technologies, Cable & Wireless Communications and Freeserve. The tenth, publisher Emap, has an online division.
Changing the rules
Why now? Firstly, index organiser Financial Times International adjusted the rules. Every three months, the FTSE 100 is tweaked so it contains the 100 biggest London-floated firms by market capitalisation - the current price of all the shares in a company.
But until now, companies with less than a quarter of their stock available to the public - such as Freeserve, which is 80 per cent-owned by retailer Dixons - were banned. Furthermore, capitalisations were calculated on the amount of stock freely available - hitting the chances of subsidiaries such as Thus, which is half-owned by Scottish Power - but are now worked out the full theoretical value.
But more importantly, stocks in new economy companies are being valued differently to those in the old, where companies are analysed on their past earnings through measures such as price-to-earnings (P/E) ratios. On the evening of Tuesday 7 March - when decisions regarding promotion and relegation were made - Imperial Tobacco's shares cost 439.5p, valuing it at £2.29bn. The tobacco products manufacturer's last reported post-tax profit was £287m. Divide one figure by the other and you get 7.9 - the P/E ratio.
The company's main rivals, British American Tobacco and Gallaher, had ratios of 8.9 and 7.2 respectively. Old economy firms in the same sectors tend to share roughly the same P/E.
Psion of the times
The papers don't list a P/E ratio for Psion, one of the firms replacing Imperial, maybe because it won't fit that measure. Psion's latest post-tax earnings are just £3.3m. On 7 March, however, the company was valued at £4.7bn, giving it a P/E ratio of 1424.
New economy firms are valued on future promise, not historical earnings."Psion's value is largely based on Symbian," said Max Thowless-Reeves, an analyst with Richard Holway, referring to the operating system co-developed by Psion for portable devices, which reportedly led Microsoft to see the firm as one of its biggest threats.
"As for Baltimore, very few people develop its kind of cryptography software. If the stock market had a set-back, companies such as Baltimore and Psion will still have good products, whereas some of the more flaky internet companies will be shown to have poor business plans."
Freeserve, one of the new FTSE 100 companies and like Baltimore a loss-maker, saw its shares crash almost 23 per cent in the first two days of last week as Altavista, NTL and BT made announcements on unmetered internet access. The Dixons' subsidiary depends on the portion of the local-call fees it collects - a revenue stream now under attack from BT - but is trying to earn more from advertising and ecommerce on its homepage. Therefore, its future business model is based on its million-plus surfers using that page regularly, and presumably not realising they can reset the homepage.
As Freeserve suggests, the entrants are likely to make the index more volatile, meaning a bumpier ride for investors holding tracker funds which mirror the FTSE 100. The same is true for pensions, although Thowless-Reeves said: "What is the risk to your pension fund if it is not investing in the firms of tomorrow?"
This week Tony Dye, who ran fund manager Phillips & Drew, retired after his strategy of investing in old economy firms making reliable profits left him behind his competitors.
In the money?
Some of the rise in IT-related shares is because of private individuals, many using the web to invest in web-related firms. This is suggested by a surge in the number of deals struck each day on the stock exchange and the booming profits of stockbrokers.
Loss-making web travel site Lastminute.com hiked its flotation price by 67 per cent, partly because of heavy demand from private individuals. Some investors are remortgaging their homes to allow them to invest, something that will leave them dangerously exposed if prices fall. Chancellor Gordon Brown has cautioned investors to look at the performance of the individual companies in which they buy shares.
But the new economy is no different from the old: companies still exist to make a profit. The only difference is that investors are now willing to predict which ones will and will not years in advance. If it becomes apparent that a firm will not come good, investors' retribution will be swift - as Freeserve showed this week.
Many are now asking when the whole stock market will drop, rather than if. "Some valuations are clearly unsustainable," says Holway's Thowless-Reeves. "And a step-back is likely to happen sooner rather than later." Don't say you haven't been warned.
|FTSE 100: Who's in, Who's out|
|Baltimore Technologies, security software house||Allied Domecq, wine and spirit maker|
|Cable & Wireless Communications, cable TV||Associated British Foods, food producer|
|Capita, business services||Hanson, building materials|
|Celltech, biotechnology||Imperial Tobacco, tobacco products manufacturer|
|Emap, publisher||Natwest*, bank|
|Freeserve, internet service provider||PowerGen, electricity generator|
|Kingston Telecom, Hull-based telco||Scottish & Newcastle, brewer and pub owner|
|Nycomed Amersham, pharmaceuticals||Thames Water, water and sewage|
|Psion, handheld device maker||Wolseley, plumbers merchant|
|Thus, business telco||Whitbread, brewer and pub owner|
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