Cisco and the Kids (corrected)

Abstract

The Nasdaq 100 Index is today's reincarnation of the Nifty Fifty. Many of today's institutional favorites feature extraordinary valuations, despite short operating histories, modest revenues, and sparse profits. At the market peak in 1972, Nifty Fifty stocks sold at an average P/E of 37.3—versus a market multiple of 18.2. At the 2000 peak, the Nasdaq 100 sold at an average P/E multiple roughly six to eight times greater than the highest P/E ever accorded Nifty Fifty stocks. Following a historic stock market correction of more than 70 percent, P/Es for Nasdaq 100 companies remain two to two and a half times higher than peak P/E valuations for the Nifty Fifty.

The Nasdaq 100 Index has become today's reincarnation of the Nifty Fifty—a group of 50 premier growth stocks identified by Morgan Guaranty Trust as stock market darlings in the early 1970s. They represented the ultimate in one-decision stock investing. No matter how high Nifty Fifty stock prices seemed relative to current earnings, superior growth would bail out any buyer. Nifty Fifty investors could not lose—until, that is, the vicious bear market of 1972–1974. The ensuing plunge in Nifty Fifty stock prices is sometimes viewed as just punishment for overvalued stocks and the naive investors willing to buy them. Widely publicized research has reported, however, that the Nifty Fifty were only slightly overvalued relative to the market at their 1972 peak. Premier growth stocks are expensive but can be worth the price.

In the late 1990s, this Nifty Fifty research was commonly cited as justification for the extraordinary valuations accorded to large-capitalization technology favorites. These citations neglected to note, however, the dismal long-run returns turned in by the highest-P/E stocks among the Nifty Fifty. They also neglected to note that Nifty Fifty tech stocks badly lagged the market and other Nifty Fifty companies.

Today's Nifty Fifty—only more so—is the Nasdaq 100. At the 2000 market peak, the average P/E for profitable Nasdaq 100 stocks was a whopping 227.8. The peak median P/E for all profitable plus unprofitable Nasdaq 100 components was an astounding 226.9, and the weighted-average P/E for all profitable plus unprofitable Nasdaq 100 companies was an astounding 311.2. By any metric, peak P/Es accorded Nasdaq 100 companies, led by Microsoft, Cisco, and a squadron of other high flyers, greatly exceeded the highest P/Es ever accorded Nifty Fifty companies.

Nasdaq 100 P/Es have remained high despite the 70 percent correction in prices since the peak in March 2000. The average P/E for 69 profit-making components of the Nasdaq 100 on March 30, 2001, stood at a lofty 71.5. The median P/E for all Nasdaq 100 components stood at 59.8; the weighted-average P/E for all profitable plus unprofitable Nasdaq 100 companies remained a lofty 97.7. The P/Es of Nasdaq 100 companies are two to two and a half times higher than peak P/E valuations for the Nifty Fifty.

Although the P/Es remain high, experience shows that new highs in returns for the Nasdaq 100 may be a long time coming. For example, if Nasdaq 100 performance follows a pattern similar to that of Japan's Nikkei Index over the past decade, Nasdaq 100 investors can look forward to a sustained period of anemic stock market returns. For the Nasdaq 100 to trade in a broad range from 1,500 to 2,500 would not be surprising. Thus, with a market return of 13 percent a year, the Nasdaq 100 would need about 10.41 years to make a sustained recovery from the postcrash low and reclaim its market peak.

I wish to thank Christine Hauschel and Susan Scholz for useful comments.