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This 20-year chart depicts the Nasdaq Composite Index, the market’s benchmark for technology and growth companies.
Like most broad market indices, it’s been on an absolute tear for the last five years. But what’s somewhat different about the Nasdaq is that it includes the same types of crazy tech stocks that were the focus of the first major bubble of this century – the dot-com bubble.
That period is clearly indicated on the chart above. And given that the index is only 7% below its 2000 peak, many market observers now wonder whether we’re in another tech bubble.
The Nasdaq gets the hairy eyeball from time to time because of this checkered past, and rightfully so. But that was then and this is now, and there are a number of legitimate reasons not to be concerned that, broadly speaking, tech stocks are in a bubble.
First, while the Nasdaq has rallied an impressive 137% in five years, it hasn’t separated itself from the broad market to the same degree as it did during the dot-com bubble. As a point of comparison, the S&P 500 is up 111% over the past five years.
In contrast, from 1995 to 2000, the Nasdaq rose by over 410% as compared to 210% for the S&P 500. That level of outperformance stands out over any time in recent history.
Second, tech stocks were so overinflated in 2000 that the sector’s weighting in the S&P 500 nearly reached 35%. Today, that weighting is much closer to 18%.
And on a valuation basis, the tech sector of the S&P 500 currently trades with a forward P/E ratio of 15.1, compared to a high of over 60 in 2000. Over the last 15 years the sector’s average trailing P/E ratio is 16.8. So by this measure tech stocks in the S&P 500 are attractively valued.
If we look at the Nasdaq, the average P/E ratio since 2003 has been 19.5, and it currently sits at 20.9. So this index is trading at a bit of a premium, but not much of one.
To me, this data all suggests that, again broadly speaking, tech stocks aren’t in a bubble. As in any market, there are plenty of examples of insanely valued companies of course, but I don’t think that applies to tech stocks in general today.
In the two advisory services I run that are focused on growth stocks, 100% Letter and Top Stock Insights, we’re actively recommending a number of tech stocks. We have a couple with premium forward P/Es in the mid-30s, but most are in the low 20s and mid-teens.
For stocks that I’m expecting to grow far faster than the S&P 500 and Nasdaq, I think it’s entirely reasonable for valuations to be at, or even above average.
My advice for tech investors right now is to stay the course. Maintain a diversified portfolio of tech stocks. Avoid the insanely valued ones, but don’t be scared to pay a slight premium for a business you have conviction in.
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