I have a question about trading tech stocks in general. According to some on CNBC, the Nasdaq is undergoing a structural change in the sense that the days of high multiple stocks are over. I would really appreciate it if you have any thoughts on this issue and if you could share with us.
The market goes in cycles. In bull runs multiples don’t mean a lot. Only when a bear market or correction occurs do the value players come out and start talking about the ‘value’ of stocks, referring to P/E ratios as being of primary importance. They look for P/E’s below 10 as good values. That is what is going on right now with the Nasdaq bear market. Is this a ‘structural’ change? For now that is all we hear on the television because growth stocks that trade at high earnings multiples are sold when future earnings expectations are lowered. So in that sense there is a change in the Nasdaq, but it is because the economy has slowed.
Is it permanent? No. When earnings expectations start to rise again based on improving economic conditions, growth stocks with the best earnings, sales, and revenue potential will start back up and will grow as long as earnings expectations for the future continue to rise. Thus, high multiple stocks are accepted in good economic times because investors can build in more expectations of growth.
Don’t believe it? A look at the biggest winners in the market year in and year out, those stocks that are leading the economy in the important sectors, start their massive runs with P/E ratios 20% higher than the rest of the market. They already have what some would consider high P/E’s before the run starts. When a run is finished, the P/E has usually run from 20 to 30 to 80 or more. 20 may have seemed high, but it is nothing compared to 80. A value investor will never get in on these stocks because the value investor will shy away from a stock with a P/E of 20 or more. Problem is, in a good economy, stocks with P/E’s of 10 or so are usually the laggards that don’t have superior earnings power or are not leaders in a leading sector that can make a huge run. You are buying mediocrity and will get mediocre returns compared to the better growth stocks.
Right now value investors are in their element, i.e., a weak economy and weak market. They still won’t touch tech stocks because even with the beating they have taken they are still ‘overvalued.’ Well, when this market starts back up and we look back, we will see that the growth stocks that took off and left the ‘value’ stocks in the dust still had P/E’s that value investors would not touch. That is history.
