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Today's Market WrapUp 05.03.2007 Mon Tue Wed Thu Fri Goldberg Archive The
Nasdaq 100 - Wall Street's Dirty Little Secret
The stock market looks at valuations, but sometimes it doesn’t see them. This is one of those times. Valuations of the Dow and S&P 500 are often discussed since they can now compare somewhat favorably with other times in recent history. What the market may not be seeing is the fact that the stocks within the major indices have just completed a multi-year run of double digit earnings growth and this cannot continue indefinitely. Still the bull case sees this double digit earnings growth resuming after the most recent quarter’s growth decelerated into high single digit percentages. And to be fair, may be this earnings growth is something that I’m not seeing. The most recent quarter’s single digit percentage earnings growth beat analysts’ “expectations” and this was the apparent reason for a sharp and erect multi-month market rally. The bear case has earnings growth decelerating in the near term future while P/E’s compress as a result and the bear market resumes. For the major indices, one can defend either the bull or bear case, but for today, the market has decided – bulls win! For tomorrow, it’s anyone’s guess. While the valuation case can be argued either way for the Dow and S&P 500, similar arguments cannot be brought forth with a straight face for the Nasdaq 100. It amazes me that there are precious few references where one could evaluate the price/earnings (P/E) ratio of this almost $2 trillion index. You can find the P/E of the Dow Industrials, S&P 500, Dow Utilities, or Transports by simply looking them up in the Wall Street Journal, Barron’s, or Investor’s Business Daily (IBD). But no such “look ups” seem to be available for the Nasdaq 100. Is there something to hide? Fortunately with the ability to download spreadsheet data from Yahoo Finance, one can easily evaluate the index as a whole as I did. What was found is staggering. The index is overpriced by any reasonable measure except for those involving technical chart analyses. If one were to ignore the components of the Nasdaq 100 with triple-digit P/E’s and those with no trailing earnings at all, the arithmetic average trailing P/E of the remainder of the companies in the Nasdaq 100 is 34.3 and the forward P/E is 22.1. Including all components of the Nasdaq 100, the forward P/E is a whopping 34.9. Earnings growth based on Wall Street analyst expectations is projected to be over 35% over the next year. There seems to be something in the collective business models of these companies that make payment of dividends to shareholders passé. While the current dividend yield of the S&P 500 is 1.91% (way low by historic standards), the dividend yield of the Nasdaq 100 is a mere 0.36% (0.5% capitalization weighted) by comparison. Given that Nasdaq 100 companies are among those most implicated for options back-dating and shareholder dilution, a reasonable person would expect that shareholders would now demand dividends and corporate managements would oblige. Forget it; beyond momentum, there is no reason on Wall Street. Analysts expect that only seven companies in the Nasdaq 100 will post lower earnings in the next year compared to the previous year. With only seven companies (7%) expecting to have an “off year,” this would seem to be a rosier forecast than any reasonable soul not from Wall Street would expect. What happens if the US economy slows? Are the rich valuations justified by corresponding earnings growth rates? A decade ago, the sector was largely unknown and misunderstood; it is 10 years later and the long term fundamental outlook can be evaluated with a higher degree of accuracy. The implied growth projections put forth for the public by Wall Street are unrealistic by any historic standards. Yet, while the Street still tells us “the sky is the limit,” the public will learn otherwise the hard way. Below is a spread sheet summary of the key fundamentals of the Nasdaq 100 with data from Yahoo Finance.
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