On March 2, 2015 the Nasdaq Composite Index, more commonly referred to as the NASDAQ, closed above 5,000 points for the first time in fifteen years. As this occurred, Wall Street trading floors swelled with the collective anxiety of investors who had observed the same milestone during the Dot-Com era (in March 2000). Only two days after the NASDAQ eclipsed 5,000 on March 9th, the tech-oriented index began its dramatic collapse; one that would last more than two years. By the time the NASDAQ bottomed, in October 2002, it had lost roughly 75% of its March 9th value.
We now use this benchmark as an opportunity to critically analyze the NASDAQ, taking into account the factors that precipitated the Dot-Com bubble and its subsequent correction. We can utilize these historical factors to assess the current risk associated with stocks that comprise the NASDAQ. However, in conducting our NASDAQ analysis, we mustn’t forget that a benchmark is not definitive. As such, the investing landscape can (and probably will) continue to trend upwards over the next few years.
The Dot-Com era NASDAQ was a completely different beast than it is today. Of the index’s top ten companies, by market capitalization in 2000, only Cisco (CSCO), Intel (INTC), and Microsoft (MSFT) remain top members. Microsoft, which peaked in 2000, with a market cap of $606 billion, now sits in third behind Apple (AAPL) and Google (GOOG), signaling a greatly diminished market share of almost $360 billion. For the sake of clarity, please remember that, as of 2000, the iPhone was seven years away from release and Google was only 18 months old (Apple’s market capitalization is currently $735 billion, the largest of any American company, whereas Google’s is $370 billion). NASDAQ sector diversity, otherwise defined as the various companies represented by the index, has also changed significantly since 2000. 57% of the companies that comprised the Dot-Com era NASDAQ were part of the Information Technology (IT) sector, while most of the remaining spots were dominated by Telecommunications businesses. Today, IT accounts for only 43% of the NASDAQ, as tech has conceded ground to biotechnology stocks like Amgen (AMGN) and Gilead Sciences (GILD), as well as hybrid tech stocks like Amazon (AMZN) and Facebook (FB).
Even more important than the NASDAQ’s composition (in 2000), were the egregious valuations of the included companies. According to data from the NASDAQ OMX Group, the index’s price-to-earnings (P/E) ratio during March 2000 was about 150. Incredibly, like something out of a fairytale, Yahoo (YHOO) traded at a P/E of nearly 800 and Cisco traded at a P/E of 200. According to many valuation methodologies, the Dot-Com era represents the most overvalued period in the stock market’s history. To put this outlandishness into perspective, today the NASDAQ’s P/E ratio is 27, whereas the S&P 500’s is 18, and Yahoo trades at a P/E of 24, whereas Cisco trades at a P/E of 16. In this regard, when compared to the NASDAQ average, both Yahoo and Cisco are actually undervalued.
During the formation of the Dot-Com bubble, investors relied on blissful speculation rather than strong fundamentals: like revenue, debt, EPS, and other traditional measures of financial health and growth potential. A prime example of this speculative environment relates to a company by the name of Commerce One. During 2000, Commerce One had a market capitalization of almost $20 billion, despite disproportionate annual revenue of only $33 million. If we set costs and inflation aside, it would have theoretically taken Commerce One 606 years to earn $20 billion (assuming a constant revenue stream). This is ridiculous! How could investors be so naïve?
In retrospect, we now empirically know the Dot-Com bubble was formed largely due to tremendous capital inflows, bullish investor sentiment, and a substantial misunderstanding of how the Internet worked; more specifically, traders seriously misinterpreted the means by which IT companies generated revenue. During the late 1990s, something as simple as adding “.com” to a company’s name could send its stock price to new highs; no wonder the NASDAQ highs of March 2000 lasted only two days. The simple fact that investors, for the most part, now better understand tech business models, strategies, and outlooks is perhaps the main reason behind today’s lower valuations. Thanks to readily accessible financial education resources, as well as the fear of another tech bubble, the newest generation of investors has inherited a much healthier and more promising NASDAQ. An index rooted in fundamentals, not faith.