In part one of this three-part series on the small trader sentiment, I introduced The Daily Sentimen...
It’s Not Your Father’s Nasdaq 3,000
03/16/2012 9:00 am EST
The technology–laden index just hit its highest level since 2000, and is poised to go higher. And the tech sector is older, wiser, and much less risky than it was a decade ago, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.
The Nasdaq Composite broke 3,000 on Tuesday for the first time since 2000.
The 11–year high for the index brings back memories of those days in 2000 when the dot–com bubble pushed the technology–laden index to a high of 5,048.62. (These days, the 500 or so technology stocks that trade on the Nasdaq market account for almost 50% of the market–capitalization weighted index.)
But breaking the 3,000 level is neither a signal to put the champagne on ice, so it will be chilled in time to celebrate the Nasdaq hitting 5,000, nor to run in fear yelling, "The sky is falling again."
Truth is, this isn’t your father’s technology sector. We’re headed neither to the moon nor into the abyss.
Which is why, even with the Nasdaq at 3,000, this is a good time to invest in technology stocks—as long as you understand the big differences between the current technology market and that of 2000.
I can think of four major differences.
1. Prices Are Reasonable Now
First, the shares of the big, established technology companies are much cheaper than they were in 2000. To take the extremes, look at Cisco Systems (CSCO) then and Apple (AAPL) now.
In April 2000, just as the bubble had started to burst, Cisco sold at a price–to–earnings ratio of 199.84, comparing the stock price at the time to trailing 12–month earnings. Apple’s March 14 price–to–earnings ratio on trailing 12–month earnings is just 16.63. (Suffice it to say, this is a common measure of a stock’s relative value—and the lower number here is a lot cheaper.)
Cisco and Apple aren’t isolated instances. Marc Faber calculated in the fall of 2000 that the Nasdaq as a whole traded at 240 times projected 2000 earnings per share. The New York Times, working the numbers today, gets a 2000 price–to–earnings ratio of 155.
(The difference, I think, depends on how you treat companies with no earnings and therefore infinite price–to–earnings ratios. There were a lot of those in the year 2000.)
The current Nasdaq price–to–earnings ratio is below 20, according to the Times. Today’s technology sector is just not as dangerous as the sector was in 2000.
Yes, technology stocks could fall from today’s 3,000 level. But the drop would likely be a correction, and not the kind of plunge that we saw from 5,048.62 on March 19, 2000 to 1,114.11 on October 9, 2002.
2. Mature Companies, Not Startups
Second, the big companies that dominate the sector’s market cap now are a lot more mature than these same (and other, now–departed) big–cap companies were in 2000.
That means there are more earnings to support prices and price–to–earnings ratios in the sector—and also lower earnings growth rates, because bigger companies, by and large, don’t grow revenue or profits as fast as small companies.
Look at the projected annual growth rates for these big technology giants in the 2012 market:
- Intel (INTC) is projected to grow by 9.9% annually over the next five years.
- Microsoft’s (MSFT) earnings are expected to grow 8.8% a year over the next five years.
- Cisco’s earnings growth is projected at 8.4% annually over the next five years.
These are the kind of growth rates you expect from companies such as Coca–Cola (KO), McDonald’s (MCD), or Walmart (WMT). Wall Street projects five–year annual earnings growth for those companies at 8%, 9.6%, and 10.6%, respectively.
Even if you go down a level in size from these tech giants to a faster–growing part of the sector, you won’t find the kind of projected growth that Wall Street publicized for the sector in 2000. F5 Networks (FFIV) is looking at 21.9% annual earnings growth over the next five years. Qualcomm (QCOM) is projected to grow at an annual 15.4% pace. Broadcom (BRCM) earns a 14.6% annual growth estimate.
One of the costs of the sector’s greater maturity is slower growth. The lower price–to–earnings ratio for the sector is largely justified. But with maturity comes stability.
3. Even IPOs Look Less Risky
If you’re looking for excess, the place to look for it in 2012, as in 2000, is in the initial public offerings in the sector. But even there, 2012 takes a back seat to the excesses of 2000.
Amazon.com (AMZN) went public in May 1997. Even though it was losing money, the company finished its first day valued at $438 million.
eBay (EBAY) went public in 1998. That company had $1.2 million in profits in the previous 12 months. The first–day market cap came to $1.9 billion. (That comes to a price–to–earnings ratio of 1,583.)
In contrast, recent flashy IPOs like Groupon (GRPN) and Zynga (ZNGA) have actual earnings and lofty, but not mind–boggling, price–to–earnings ratios. Groupon trades at 81.54 times projected 2012 earnings. Zynga goes for 51.74 times projected earnings.
Even Facebook, which is projected to go public in May, doesn’t hit the eBay scale. The company had $1 billion in earnings in 2011, and is projected to go public with a market cap of $100 billion, for a price–to–earnings ratio of just 100.
One of the reasons for the ratcheting down of expectations is the experience of 2000. Amazon and eBay—and even companies such as GeoCities and Broadcast.com—all looked as if they would change the US economy. Amazon and eBay would revolutionize retailing, for example.
Now, there’s a lot of excitement about the initial public offerings of companies like Groupon, Zynga, and Facebook. But the expectations are more modest. The market sees these companies as extraordinary new advertising and marketing vehicles, for example, but they’re an incremental step—perhaps a huge one and perhaps not—from Google (GOOG).
4. Less–Sweeping Technological Change
If I can vastly overgeneralize, technology in 2012 feels much less revolutionary, disruptive, and creative–destructive than it did in 2000.
Amazon did indeed revolutionize retailing, and the landscape is littered with a trail of the corpses of companies that couldn’t compete, ranging from Borders to Circuit City. I’d be surprised if the next five years didn’t see an obituary for Sears (SHLD), Best Buy (BBY), Barnes and Noble (BKS), or some other major retailer.
In 2000, Cisco and its Internet equipment fellows did kill Lucent Technologies and Nortel, two of the really big players in telecom equipment. Wireless phones powered by companies such as Qualcomm did force phone giants to become wireless giants.
There’s certainly some destruction going on today. Hewlett–Packard (HPQ) and Yahoo (YHOO) are fighting for relevance. Nokia (NOK) is fighting to reinvent itself. Intel and Microsoft are struggling to make their traditional strengths count in a new environment.
But with the exception of Apple, no technology company in 2012 looks as if it will reshape the competitive playing field, as Amazon did in the technology wave that peaked in 2000, or as Google (a 2004 IPO) did slightly later. (And there are those who doubt even Apple’s credentials as a game–changer, saying the company is better at exploiting existing trends than creating new ones.)
Many of the most interesting companies in the 2012 technology wave seem instead pick– and shovel–builders (Rackspace Hosting (RAX), for instance), exploiters of new platforms (Groupon), or extenders of business strategies (Facebook from MySpace, for example).
The New Tech Investing
What does this extended comparison suggest about investing in technology now?
- That investing in the big, mature technology companies isn’t about just growth anymore. It’s about dividends. (Intel pays almost 3%.)
It’s about the tradeoff between predictable earnings and lower earnings growth, in which predictability contributes a substantial portion of the stock’s valuation, just as it does with Coca–Cola or Procter & Gamble (PG).
And it can even be about value. In fact, two of the most interesting, big, mature technology stocks in this market are value plays.
Microsoft trades at just 12.1 times trailing 12–month earnings—and don’t forget to throw in the company’s 2.2% dividend yield. What makes that valuation so interesting is the introduction of the Windows 8 operating system (including a version for tablets) and the first update of its new Windows Phone operating system (Windows Phone 7.5, or Mango), both due this fall.
The new operating systems embrace touch–screen user interfaces, cloud computing, instant–on, and lower power consumption that, on the evidence of Nokia’s new phones using Windows Phone 7, could make Microsoft a strong No. 3 in the wireless phone and tablet markets, behind Apple and Google’s Android. That would be quite an achievement for a company considered irrelevant in those markets just a year ago.
Standard & Poor’s projects that Microsoft’s earnings in the fiscal 2013 year, which begins in July 2012, will climb by 12.5%.
And Microsoft’s success makes Nokia’s save–the–company bet on switching to Windows Phone seem like a gamble that has a better chance to pay off than skeptics initially imagined. Nokia is still bleeding market share, as fewer and fewer customers want to buy a phone with the soon–to–be discontinued Symbian operating system.
Nokia’s revenues fell 5% in 2011, and are forecast to drop an additional 3% in 2012. But that’s actually progress, and Credit Suisse—one of the few Nokia bulls—believes that the company’s share of the wireless phone market will stabilize near 13% in 2013.
- If you’re looking for something closer to the earnings growth rates of the 2000 wave of technology stocks, think smaller and more focused, rather than bigger.
F5 Networks, a networking company with a much tighter focus than Cisco, is growing about twice as fast.
LSI (LSI), a chipmaker that specializes in high–end storage and networking chips, is forecast to grow earnings by 24% in 2012 and 34% in 2013. That’s a bit better than the 9.9% annual growth projected for Intel over the next five years.
VMware (VMW), a maker of virtualization software, is forecast to grow earnings by 24% annually over the next five years, versus 8.8% annual growth for Microsoft.
- If you’re looking for technology companies built around new ideas, don’t forget the companies that enable bigger technology trends.
Aruba Networks (ARUN), for example, specializes in hardware and software that let mobile devices—such as iPhones—securely access corporate networks.
Digital Realty Trust (DLR) owns a portfolio of 102 data centers in 31 markets serving clients that include Facebook, AT&T (T), and Morgan Stanley (MS). Organized as a real–estate investment trust, Digital Realty pays a 3.8% dividend.
Apple is a 10% customer at Broadcom, and Credit Suisse estimates that the chip company has $6 to $10 of its products inside every iPhone and iPad.
- If you can get in on a hot technology IPO, do so—and flip it.
Nobody is getting the 250% first–day gains that investors in Broadcast.com reaped on its first day of trading, but the 109% jump in the price of LinkedIn (LNKD) on its May IPO is still decent pocket change.
Just don’t stick around too long. The stock fell to $70 on November 21, when the six–month lock–up period expired and company insiders were able to sell shares.
Finally, of course, there’s Apple itself, although the stock—almost $590 at the close on March 14—is getting close to the $650 level where I think Apple may have to rest and consolidate a new base.
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