What's the difference between old- and new-economy stocks?

By Investopedia Staff AAA
A:

Old-economy stocks represent large, well-established companies that participate in more traditional industry sectors and have little investment or involvement in the technology industry. These old-economy companies' business activities dominated the economic landscape before the dotcom era of the late 1990s ushered in an entire industry of new, high-growth companies. Old-economy stocks typically exhibit relatively low volatility and usually pay consistent dividends as they operate in mature industry sectors, which do not always offer new investment potential for a company's cash.

In contrast, so-called new-economy stocks are heavily involved in the technology sector and the more successful companies are able to build value at markedly higher growth rates. Good examples of new-economy stocks would be companies whose primary operations are involved in ecommerce or technology-based activities, such as Google, eBay, Cisco and Intel. These companies generally operate in significantly different business environments than old-economy stocks and their stocks are generally more volatile. New-economy stocks tend not to pay dividends, opting to reinvest their cash into business expansion.

Old- and new-economy stocks differ not only in their business activities but also in the way they are valued by the market. Valuations of new-economy stocks tend to see stronger volatility, since their business models are not as stable as old-economy stocks and are generally found in relatively new industries. On the other hand, old-economy stocks tend to be valued based on are more stable business models and less robust growth expectations, resulting in less variance of analyst expectations and more accurate earnings estimates. Generally speaking, when analyzing a new-economy company more focus is placed on growth expectations and earnings estimates several years down the road, which are much less easier to predict when a company does not have a lengthy track record. Also, new-economy stocks, even those which already turn consistent profits each quarter, tend not to pay out dividends to their shareholders, opting instead to reinvest earnings into business operations as they are much more likely to capitalize on high-growth opportunities than old-economy companies in mature industries.

Due to the relatively strong impact future earnings estimates have on new-economy stocks, these types of companies are moderately more prone to overvaluation than well-established companies. The dotcom bubble of the late 90s saw an explosion of new-economy companies with seemingly limitless potential. Many glamorous tech stocks with no earnings to their name were driven up in price to very high levels as the market became overly exuberant about the sector's prospects, only to fall back down to much lower price levels as the bubble burst. However, these stocks continue to be more volatile than old-economy stocks, and often exhibit higher P/E ratios as well since they are expected to grow at relatively faster rates in the future than the old-economy companies.

(For further reading, see When Fear And Greed Take Over and How Dividends Work For Investors.)

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