A seven-stage guide to getting in on the gold rush

'Four years ago investors thought AOL's $1bn value absurdly high'
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Whether you believe the high technology sector is a bubble or a bonanza (and there are good reasons to believe it is both), from an investment point of view, it closely resembles all previous new investment sectors.

Whether you believe the high technology sector is a bubble or a bonanza (and there are good reasons to believe it is both), from an investment point of view, it closely resembles all previous new investment sectors.

That is the view of Henry Blodget, head of Merrill Lynch's global internet research team. In a recent booklet for clients he parodies Shakespeare's "seven ages of man" by suggesting that when a new technology comes along, there are always "seven stages of investment". It is a neat idea that deserves a wider airing.

The first stage is promising opportunity. The prospector may think there is gold in the hills but he needs shovels to dig for it. So the venture capitalist funds the dig in exchange for a share, maybe a large share, in profits.

Stage two is the first find. A few prospectors do strike gold, the word gets round, the returns on the initial investment are enormous. Those high returns hasten stage three: the next bout of investment, for more money floods in. But each new dollar of investment buys a much smaller stake. That burst of investment in turn leads to stage four. As the money floods it, it leads to more competition and higher costs. The going gets tougher for the prospectors.

This tougher climate for the prospectors has its impact on their backers as the opportunities for investors fall: stage five. The good sites are all taken, and costs are high.

So, stage six, investment returns fall, and finally, stage seven, those falling returns stop new investment. The gold rush is over.

The point Merrill Lynch make here is that to make money out of new technology you have to get in early. Investors in AOL four years ago might have thought a valuation of $1bn absurdly high but they would have been wrong. The end of the gold rush came this year with the cutting of new investment and a collapse in the price of hi-tech shares.

So it is great if you get in early but glum if you don't. That would be unhelpful advice to today's investors were it not for another characteristic of the internet, its variety. The better news for investors, says Merrill Lynch, is that this is a segmented market. Though the shares of the early prospectors, companies such as Amazon, have been weak, there are new opportunities in the portals, and so on.

There are further points. One is that the best investments in the gold rush were not the prospectors but the shovel-makers, the people who ran the infrastructure, or more famously, made Levi's jeans. The greatest of prizes now will be for suppliers of systems and equipment.

That point has already been reflected in the prices of companies including Cisco Systems or Nortel Networks, so maybe the opportunities there for investors arriving now are limited. There will be new shovel-makers emerging all the time, but so many people are hunting them it is hard to sniff them out before the other investors get there.

That leads to the second point. One of the differences between the internet and other new technologies is that it is a production method as well as a product. The gold rush analogy is useful as far as it goes, but I prefer the analogy of the moving production line.

The first motor cars, including those made by Henry Ford, were made in batches by craftsmen. Then Ford organised first, the static production line, then, after watching beef carcasses moving on chains in Chicago slaughter houses, the moving one. This revolutionised car manufacture (and the manufacture of consumer goods) by cutting the costs of making cars and paying the staff more, so the people who made the goods could afford to buy them.

In the next 20 years, there will be enormous scope for investment in ordinary companies that use the new technologies particularly well, rather than the specialist internet companies themselves. Why 20 years? Because figuring out how to apply any new technology to a profitable commercial use takes a long time. If you look at a car production line now it does not seem very different from one of 20 years ago, except in one crucial respect. There are far fewer workers. Productivity has gone up threefold over two decades. That is thanks to a string of detail refinements , rather than a single leap forward.

Expect much the same to happen to, say, internet banking. There is not going to be a sudden advance over the present, still slightly user-unfriendly methods of making transactions. But there will be a host of incremental advances as the banks discover what we, as customers, really want and figure out ways of meeting our desires.

But how do you sort the sheep from the goats, the companies which are really applying the new technologies wisely rather than those who just make a lot of noise about it? For professional investors there are the professional investment advisers, the cohorts of analysts trawling the corporate world trying to figure out which ones really know their stuff. For the ordinary private individual without access to this expertise there is an alternative route to wisdom - looking at websites.

It is amazing how the hype differs from the reality. So many organisations proclaiming they are wonderful at some branch of e-commerce have websites that are disgraceful, clumsy, confusing, slow to download, riddled with grammatical errors. Others have ones that are smooth and splendid. That tells you something about the e-competence of businesses - and offers a guide to investors who want to do it for themselves.

The rule for would-be investors has not changed much, just the mechanics. A century ago, a wise investor might have gone into a Marks & Spencer or a Sainsbury store, discovered it seemed better-run than its competitors and invested in the company. Now you visit it on screen. If the seven stages of investment have not changed, maybe the one rule of how to pick good companies has not changed either.