I’m wondering how many of you that well remember the tech boom at the turn of the century think a similar situation is forming, at least among some key tech stocks driving the Nasdaq today.
While I’m not going to name specific tech companies, I’ve noted a significant number that are racing ahead on recent strong earnings reports. While it’s reasonable that earnings growth would be rewarded with higher valuations since earnings drive stock prices, the P/E ratios are starting to price in a ton of future earnings growth. This is a key marker I recollect in the 90s leading into the year 2000. Dot com stocks from that time were often experiencing robust earnings growth but stock prices had raced far ahead in terms of the level of earnings being assumed by the stock price. That is, a lot of future growth in earnings was being assumed by the stock prices.
We all know what happened. Earnings started to slow and 2000 and the next several years saw stock prices descend as fast as they had gone up. A significant number of companies from that time were either absorbed by other companies or no longer exist due to bankruptcy.
It’s always important to own valuable companies and those with healthy balance sheets. From my personal vantage point, it is a heightened time for that thinking once again. Many of those high-flying companies before the dot com crash attracted many investors near the heights. As I wrote in my book, “Choose Stocks Wisely,” I was caught in that euphoria and that hard lesson was a key factor in driving me to the balance sheet strategy I favor today.
Have a good weekend and next week, friends.
Yes, fortunately I guess, I do remember the dot-com bubble, but unlike Lawrence Welk’s theme song, it wasn’t a tiny bubble, and I do know what happened. I have a scared memory as a reminder. But like you say it is always important to own valuable companies, and some of these high flyers that are up because they have real earnings and growth will return to value levels. It will be important to recognize that value when it exists.
For me, Friday seemed like some rotation as there was a distinct difference in advancing vs declining volume on the two exchanges. On the Nasdaq, Advancing Volume was 1.25 billion vs Declining Volume of 1.87 billion shares. But on the NYSE, Advancing Volume was 2.65 billion vs Declining Volume of 1.34 billion shares. I think money was moving out of some overvalued tech and into more reasonably valued issues in other sectors.
Thanks for your posts, they keep me and I’m sure many others grounded.
Thanks for sharing the excellent comments, Julian. Looking at the advance vs. decline ratios is enlightening. Your statement “It will be important to recognize value when it exists” is very sensible when considering what might lie ahead. Indeed there are some tech high flyers this time that have real earnings and growth in the mix. Thanks.
Thank you Dr. Allen for this important reminder. Could you give an example mathematically of how a stock’s price reflects assumptions about its growth of earnings? I hear this expression many times in articles but have never actually seen the math worked out.
Thank you very much for your book and continuing to share your thoughts.
Hey David. I may state this overly simplistic but like to err on that side of explanation vs. overly complicated. Basically, if a stock is trading at a P/E of 100, for example, future annualized growth is being assumed to be 100 percent. There is a ratio known as PEG, or P/E to G where G is the projected 5 year annualized growth rate. In theory, a company is fairly valued when its P/E equals projected G. That is, if expected G is 20 percent, then a stock is fairly valued (according to PEG theory) at a P/E of 20. Thus, a neutral (fair value) PEG would be 1.0.
Well, there are presently tech stocks with strong future growth rates being projected by analysts. The stock price is “assuming” these growth rates when it advances its P/E to equal the annualized growth rate. If it is trading at a P/E of more than the projected growth rate, it is assuming higher growth than what’s projected. That is, the PEG rate would be over 1.0. A company with a P/E of 30 and projected G of 20 percent, the PEG would be 1.5 (30/20 = 1.5).
I’ll conclude by saying that I’m seeing tech stocks with PEG ratios running well, well above 1.0. This suggests that investors are paying a sticker price for some stocks that are not only “pricing in” analyst optimism toward future earnings growth but also pricing in additional growth beyond what analysts expect.
I hope this is useful.