Why Tech Is A Bad Bet
This is the title of an interesting article (on page 131)in the current edition of Fortune magazine. It tells how it is now five years since the NASDAQ began its free fall and that the case for jumping back into tech stocks appears to be more than a little convincing. However, while the Dow has regained much of the ground that it lost when the bubble burst, it still remains 60% below its March, 2000 peak. Also, after a relatively robust showing in 2004, it's down by 10% so far this year.
The tech sector happens to be the place that large mutual funds like Fidelity's Magellan and Vanguard's Capital Opportunity Fund are putting 17% and 31% respectively of their portfolios at this time. Plus, virtually every one of the 250 growth funds that Lipper tracks has tech as its largest sector holding with an average weighting of about 25%.
Well, we're here to tell you that tech is an absolutely disastrous place to invest right now. Why? Because the large and small players in telecom, software, the Internet, and chips are still trading at valuations that can't be supported by reasonable math. Their earnings are still puny compared with their stock prices. And given their modest prospects for growth, it's virtually impossible for them to expand profits fast enough to reward investors.
For the purposes of this argument, we'll use the NASDAQ 100 (NYSE: QQQQ) as a proxy for the entire technology sector. The NASDAQ 100 encompasses most of the big tech names such as Intel, Microsoft, Yahoo and eBay. To simplify, we'll treat the NASDAQ 100 as if it were one big company and see whether you'd want to buy its stock.
Currently the NASDAQ 100 companies are earning $55 billion a year, based on their cumulative profits over the past 12 months. Their combined market cap is $1.82 trillion. So the price/earnings ratio is 33, and that's already a frightening number. Add to that the fact that companies don't have to subtract stock-option expense from earnings, even though it's a real cost to shareholders.
For the NASDAQ 100, the hidden cost of options is staggering. In the most recent fiscal year, it hit 17% of reported earnings at Intel; 28% at Cisco; and 27% at Dell. All told, option costs not included in official net earnings reached $12 billion for the most recent fiscal year. That reduces earnings for the NASDAQ 100 from $55 billion to $43 billion. Hence, the real P/E ratio, the one that matters to investors, isn't 33 but 43!
Taking out the huge run-ups before the 1987 crash and the start of the late 1990's bubble, the P/E of the NASDAQ 100 has averaged around 23. The best bet is that it falls back to around that number or even lower. That implies that the NASDAQ as a whole must fall to around 1000, or by 50%, before investors should get back in.
So ignore the happy talk and hoard your cash until the inevitable, wrenching correction makes tech a good buy again. It's bound to happen. The math says so!
* * * * *
The tech sector happens to be the place that large mutual funds like Fidelity's Magellan and Vanguard's Capital Opportunity Fund are putting 17% and 31% respectively of their portfolios at this time. Plus, virtually every one of the 250 growth funds that Lipper tracks has tech as its largest sector holding with an average weighting of about 25%.
Well, we're here to tell you that tech is an absolutely disastrous place to invest right now. Why? Because the large and small players in telecom, software, the Internet, and chips are still trading at valuations that can't be supported by reasonable math. Their earnings are still puny compared with their stock prices. And given their modest prospects for growth, it's virtually impossible for them to expand profits fast enough to reward investors.
For the purposes of this argument, we'll use the NASDAQ 100 (NYSE: QQQQ) as a proxy for the entire technology sector. The NASDAQ 100 encompasses most of the big tech names such as Intel, Microsoft, Yahoo and eBay. To simplify, we'll treat the NASDAQ 100 as if it were one big company and see whether you'd want to buy its stock.
Currently the NASDAQ 100 companies are earning $55 billion a year, based on their cumulative profits over the past 12 months. Their combined market cap is $1.82 trillion. So the price/earnings ratio is 33, and that's already a frightening number. Add to that the fact that companies don't have to subtract stock-option expense from earnings, even though it's a real cost to shareholders.
For the NASDAQ 100, the hidden cost of options is staggering. In the most recent fiscal year, it hit 17% of reported earnings at Intel; 28% at Cisco; and 27% at Dell. All told, option costs not included in official net earnings reached $12 billion for the most recent fiscal year. That reduces earnings for the NASDAQ 100 from $55 billion to $43 billion. Hence, the real P/E ratio, the one that matters to investors, isn't 33 but 43!
Taking out the huge run-ups before the 1987 crash and the start of the late 1990's bubble, the P/E of the NASDAQ 100 has averaged around 23. The best bet is that it falls back to around that number or even lower. That implies that the NASDAQ as a whole must fall to around 1000, or by 50%, before investors should get back in.
So ignore the happy talk and hoard your cash until the inevitable, wrenching correction makes tech a good buy again. It's bound to happen. The math says so!
* * * * *
posted by Bob Moser at
8:50 PM
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