Tags: Tully | Nasdaq | index | funds

Fortune's Tully: Nasdaq Index Funds Are Risky

By    |   Wednesday, 07 May 2014 12:14 PM

So you think investing in a Nasdaq index fund will lower the stock market risk because it contains a wide range of stocks? And you think the Nasdaq's 6 percent drop during the last two months offers a great buying opportunity?

Think again.

A Nasdaq Composite or a Nasdaq 100 index fund are a small collection of expensive, volatile stocks — the opposite of broad-based, value investing, explains Shawn Tully, Fortune's senior editor-at-large. That's because both indexes are capitalization weighted, which means companies with larger valuations make up a larger percentage of the indexes.

Editor's Note:
18.79% Annual Returns ... for Life?

It's a group of mostly high-flying, glamorous stocks, mostly biotech, social media and Internet companies. There's Apple, Amazon, Facebook, Google, Yahoo and Chinese search engine Baidu. For biotech, you've got Amgen, Biogen Idec, Celgene, Gilead, Mylan, Regeneron and Vertex.

These 13 companies have a combined valuation of $1.57 trillion. That's almost half of the Nasdaq 100's total valuation of $3.16 trillion.

The companies will have to produce extremely robust earnings to justify their high valuations, Tully argues.

"And if they fall short — a strong possibility, it would seem — shareholders will get severely punished," he notes.

Although the "Big 13" holds almost half the index's market-cap weight, they've got just 25 percent of its revenues. Based on four quarters of trailing profits, their overall price-earnings (P/E) ratio is 20, not cheap but not outrageously unreasonable. The problem is that not counting Apple, which earns over 70 percent of the group's profits, the rest have a combined P/E ratio of 40.

"In short, you're betting that the 40 P/E won't collapse like a souffle if (or when) the hoped-for, gigantic earnings growth fails to materialize," Tully writes. "How should I put this? That's sweet in its naivete."

Others have are warning of a tech bubble.

"There is a clear consensus that we are witnessing our second tech bubble in 15 years," hedge fund manager David Einhorn wrote in a note to clients, the Los Angeles Times reports. "What is uncertain is how much further the bubble can expand, and what might pop it."

"There's absolutely a frothiness out there in certain sectors," Greg Becker, chief executive of Silicon Valley Bank tells the Times. "With some of these companies, we've never seen growth rates like this before. How much is that growth worth? What's the value? That's what people are trying to get their arms around."

Editor's Note: 18.79% Annual Returns ... for Life?

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So you think investing in a Nasdaq index fund will lower the stock market risk because it contains a wide range of stocks? And you think the Nasdaq's 6 percent drop during the last two months offers a great buying opportunity?
Tully, Nasdaq, index, funds
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2014-14-07
Wednesday, 07 May 2014 12:14 PM
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