Using the word "bubble" on Wall Street is a bit like yelling "fire" most other places. The threat of a stock bubble induces panic, mainly because we never know we are in a bubble until it bursts. Usually there are telltale signs, but they tend to be dismissed because of the economic good times that precede the bursting bubble. Excessive revenue expectations and overvaluations are rationalized, and sometimes even declared the new normal.
Given today's market hypersensitivity and the long bull run that recently fell into correction, there is talk of another tech stock bubble analogous to the dot-com bubble that popped in March of 2000. Thirty long months of bear market followed that particular bubble. Could we be in for a similar fate in 2016? With stocks, it is wise never to say never, but it seems unlikely that we are in a tech bubble at the moment.
As we discussed in a previous article, the 2000 dot-com bubble was driven in large part by the endless optimism brought on by the widespread adoption of Internet commerce. It seemed that any enterprise could establish an Internet site and gain immediate value without the earnings to back it up, or even a solid plan to achieve those earnings. Remember Pets.com? Today's market has a healthy skepticism that is keeping stock prices in a relative degree of check.
The tech-heavy NASDAQ has recovered from its recent correction and it is approaching its previous high of 5218.85 that it reached on July 20th. However, there is more of a basis for the valuations. Consider the price-to-earnings (P/E) ratios during the two eras. The five largest tech stocks as measured by market capitalization in 2000 had an average P/E ratio of 124.6. Today's five largest tech stocks have an average P/E ratio of 124.4. That is still overvalued, but nowhere near the overvaluation of 2000.
The earnings component is also considerably different. Many of the inflated P/E ratios in 2000 came from disappointingly low earnings. Revenue did not, and could not, match unrealistically high expectations. Today, when tech giants report lower earnings, it is from plowing money back into the company for ambitious development projects as Facebook (NASDAQ: FB), Google/Alphabet (NASDAQ: GOOG), and Amazon (NASDAQ:AMZN) have done in the past. Meanwhile, Apple (NASDAQ: AAPL) has arguably morphed into more of a stable blue chip stock than a growth stock.
If you are interested in investing in tech companies, start by clearly defining your objectives and tolerance for risk. Are you looking for dividends in more stable and established companies like Apple and Microsoft (NASDAQ: MSFT), or are you looking for growth vehicles?
For blue chips, focus on looking over their new product lines, market shares, and upcoming competitors. Within tech, companies have a tendency to invade each other's territories if they spot an opening. Look over earnings trends and predictions as well as the analysis of the upcoming products.
For growth stocks, start by evaluating the current revenue and earnings and how those are changing over time. Do their earnings and revenue projections match up with their business plans? Are their plans overly optimistic in the eyes of experts? Do they meet product introduction dates and expectations or do they tend to lag? If you are not comfortable with your findings, look elsewhere.
If they fit in your portfolio and meet your risk and return expectations, do not be scared off tech stocks by talk of a bubble. Signs of a true bubble are scarce at this point.