A surge in technology stocks over the last year pushed the Nasdaq Composite Index to a 15-year high in July, although this has raised concerns in some corners that the market may be facing another bubble, such as the one experienced during the dotcom frenzy of the 1990s.
With a 52.3 percent return, the technology-laden Nasdaq outperformed all other major U.S. equity indexes over the 3-year period ended on August 31. By comparison, the S&P 500 increased 37.1 percent and the Dow Jones Industrial Average rose 24.2 percent. Nasdaq outperformed these broad indexes over the past 12 months, gaining 3.9 percent as of the end of August, compared to a 3.2 percent decline for Dow Jones and a 1.5 percent drop for the S&P 500. Nasdaq also surpassed its all-time high in July, which was last set 15-years ago—when the dotcom bubble expanded and then popped (see Exhibit 1).
Despite their lofty returns, today’s tech companies are not the second coming of Pets.com, one of the poster-children for the overvalued and overhyped stocks of the 1990s. Share prices and market capitalizations may be rising today, but a number of tech companies are more profitable, many have plenty of cash on hand and valuations that are justified by fundamentals. The industry is also no longer a novelty—technology has entered “middle age,” and now comprises 20 percent of the overall S&P 500 index, the largest sector in the index.
We believe there are many important differences between “then” and “now,” and that tech stocks are anything but monolithic. There are newcomers and legacy companies, and some from each camp offer compelling cases for investment. What’s more, we believe that because of solid fundamentals, today’s tech sector offers both value and growth opportunities, making it an important part of any U.S. equity strategy.
In stark contrast to the late 1990s, tech companies have some of the highest cash positions among all companies in the S&P 500 Index. Some well-known tech companies essentially have become value plays, yielding dividends of 3 percent or more. During the dot-com bubble, valuations often were based on a company’s intangible “potential,” while today valuations are backed by cash flow and cash holdings. Companies are generating actual revenue from real customers.
Valuations are far lower and more in line with the overall market today. In 2000, for example, the biggest companies by market value in the S&P 500—Microsoft, Cisco Systems and Intel—had forward multiples of 59.7, 132.9 and 44.8, respectively. As of June 30, the biggest tech companies—Apple and Microsoft—had forward multiples of 13.2 and 16, respectively (see Exhibit 2). The sector as a whole is trading below its 15-year average for forward earnings (see Exhibit 3).
Technology companies, by and large, also have plenty of cash in reserve, and some have initiated or enhanced dividends in recent years. The tech sector as a whole was the only one in the S&P industry groups with positive net cash per share, which means it has capacity to keep paying dividends to investors who are seeking current income and are less concerned with market appreciation. (see Exhibit 4)