Some market analysts believe the Nasdaq Composite index will explode past 5,000, surpassing its all-time high set during the dot.com boom.
As
Fortune Senior Editor at Large Shawn Tully sees it, the math simply doesn't add up. In a nutshell, he writes, valuations are too high and prospects for revenue growth needed to justify rising prices are too remote.
The largest 30 firms in the Nasdaq, which have a combined value of $3.37 trillion, about two-thirds of the Nasdaq 100 total, have a price-earnings (P/E) ratio of 21.6 and have a dividend yield of 1.5 percent, much less than the S&P 500 average of about 1.9 percent.
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Investors are seeking a total return of about 6 percent after inflation. A quarter of that will come from dividends - the rest from earnings growth. That earnings growth is the key to valuing the Nasdaq firms, he says.
"How fast do total profits need to expand, you might ask, to generate a real capital gain of 4.5 percent a year — or a 6.5 percent capital gain including inflation? The answer is a lot faster than 6.5 percent."
Tully estimates their P/E ratios will drop 0.5 percent a year as the companies mature until the ratio reaches about 17 in a decade.
Earnings-per-share growth is more important in the analysis than is growth in profits overall, he argues. Rather than repurchasing shares, Nasdaq firms tend to issue more shares to raise capital — an action that dilutes shareholders.
If top 30 Nasdaq firms issue just 2 percent more shares than they repurchase, they'll need to generate earnings-per-share growth of 9 percent — the 6.5 percent goal, plus enough to make up for declining P/E ratios and shareholder dilution.
Tully estimates that they group must increase earnings by 9 percent a year to keep investors happy.
"It won't happen. The reason is that earnings — to say nothing of profit margins — are already at all-time highs," he writes, saying believing their strong earnings growth can continue requires "a leap of faith."
Scott Kupor, managing partner and chief operating officer at technology investor Andreessen Horowitz, argues that tech firms are not overvalued.
"Today's technology companies are going after massive markets, the value of which dwarfs that of previous generations of tech companies," he writes in an article for
Fortune.
"Simply put, the winners in tech today can become massively larger than the winners of yesteryear because the end-user markets into which they can sell are enormous."
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