Summary: With the NASDAQ Composite back to the magic 5,000 level, today we look at the “Heavy hitters” in the index. The companies with the top 10 weightings comprise some 32% of the entire index, led by Apple (9.9%), Microsoft (4.8%) the two flavors of Google (4.6%). So where do NASDAQ Comp valuation levels sit at 5,000, and what do you get for your money? Forward P/E multiples based on analyst expectations are 19x earnings, a noticeable premium to the S&P 500 at 17x. In return for that markup, those top 10 names in the NASDAQ offer the promise of real revenue and earnings growth. Analyst estimates for top line growth in 2015 for the top 10 names average out at 13.7% and the 3 year CAGR through 2017 is 11.2%. That translates into 9.4% earnings growth for this year and 11.7% compounded growth through 2017. The real question behind NASDAQ 5,000 Version 2.0 is simple: what price do you pay for growth stocks versus the broader index.
There is an old adage popular among stock traders with more than few prematurely grey hairs: “Early is the same thing as wrong”. Financial assets move on an alchemy of hope and reality, and it’s a fine balance between the two. You aren’t really predicting the future when you choose an investment; you are predicting what other people will think in the (hopefully) not too distant future.
Case in point: the NASDAQ is back to 5,000 for the first time since March 2000. Back then, we were all going to do everything online and have it delivered almost immediately. Businesses would use the Internet to organize their supply chains. Granted, the companies promising these changes were immature - to say the least. Still, for those of us who lived through the late 1990s, the excitement around technology stocks was all encompassing. All the classic signs of a mania, right down to taxi drivers offering up stock tips based on overhead conversations, were front and center.
As it turns out, the cab drivers weren’t so much wrong as they were 15 years too early. The Internet is actually pretty useful. You can order things online, or meet your future spouse, or plan a vacation. And you can even order a livery car pickup on your smartphone, a device that was more the property of the late Mr. Spock in 1999 than the everyday reality of we have today. I suppose it will be Uber drivers with all the hot tips whenever markets peak again.
So now that “Tech promise” has become “consumer reality”, what does the 5,000 level on the NASDAQ Composite really mean? The last time we were here, things ended badly. And with the Comp up some 5.7% year to date, 16.3% over the last year, and 123.8% over the last 5 years, it’s not like NASDAQ 5,000 should be a surprise. In the words of market sage LL Cool J “Don’t call it a comeback. I’ve been here for years”.
One way to look at the NASDAQ Composite is through the lens of its top 10 positions. We’ve created several tables and onservations on these super-capitalization names:
- The top 10 stocks in the NASDAQ represent 32% of the entire index. These include Apple (9.9%), Microsoft (4.8%), the two classes of Google stock (4.6%), Amazon (2.3%), Facebook (2.3%), Intel (2.1%), Gilead (2.1%), Cisco (2.0%) and Comcast (1.7%).
- Just 3 of these names are up 10% or more on the year, and therefore disproportionately contribute to the Comp’s overall return. They are Amazon (up 24%), Apple (up 17%), and Gilead Sciences (up 10%). Two names are actually down on the year – Microsoft and Intel.
- The average price/earnings ratio for these most-important names in the NASDAQ is 19.1x this year’s expected earnings. Well, to be entirely truthful that number is actually 111.0x. You need to exclude Amazon’s 938x multiple, which we will call an outlier, to get to that normalized 19x earnings number. For comparison’s sake, consider that the S&P 500 trades for about 17x this year’s expected earnings of $125/ share.
- So is the NASDAQ cheap, or expensive, or just right? Valuation, like beauty, is always in the eye of the beholder. So let’s behold what kind of fundamental growth you get for 19x… Looking at expected revenue growth, analysts expect the Top 10 NASDAQ names to post 13.7% revenue growth this year (13.5% without Amazon) and 11.2% compounded growth through 2017. That nets out to 9.4% earnings per share growth (less Amazon) for this year and 11.7% compounded EPS growth over the next 3 years.
- If you don’t think low-double-digit top and bottom line growth is all that impressive, just look around. Growth is about as rare as hen’s teeth or an investment grade bond yielding over 4%. Many companies in the S&P 500 will struggle to show any top line growth in 2015, especially if they have significant overseas operations. Add to that “Scarcity of growth” value the fact that these companies are large enough to allow virtually any investor to buy them in size, and you have the entire rational behind NASDAQ 5,000, Version 2.0.
In short, we are back at 5,000 because the scarcest commodity in capital markets today is fundamental growth. Now, whether or not these companies can live up to their promises is another matter. Clearly enough investors think they can – hence the return to the same level as 1999. If they fail to deliver, it will at least be a different disappointment from the last go-around.
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