Recently, a lot of professional investors, fund managers, and traders have been talking about the “ridiculous” valuations of large cap tech stocks. All of these stocks are great companies but have sky-high price/earnings ratios. And since these companies are already large cap, they will never be able to grow their earnings enough to justify their valuations in the long term.
Here are some examples of large cap companies whose stocks are overvalued but have still soared recently.
Amazon’s stock price has soared. Its P/E ratio is around 186 and has a market cap of $480 billion.
Netflix’s stock has also soared. It has a P/E ratio of 213 and a market cap of $70 billion.
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Tesla’s stock has gone through the roof in 2017. It has a market cap of $53 billion and no P/E ratio because Tesla doesn’t earn a profit.
Salesforce has a market cap of $65 billion while it’s P/E is 481.
It’s important to remember that as long as this bull market continues, these “overvalued” companies will become even more overvalued.
- Corporate earnings are increasing, so stock prices have to rise just to maintain their current P/E ratios.
- The masses are drinking the Kool-aid, and their buying will cause these stocks to remain the leaders in this bull market.
The market can remain irrational longer than you can remain solvent.
Right now, our model does not foresee a bear market or a significant correction. So these stocks will continue to see strong gains at least over the next 1-2 years.
Yes, valuations right now are high. Google has a P/E ratio of 32. Microsoft has a P/E ratio of 30. Facebook has a P/E ratio of 38. (The long term historic average is 17).
Hence, some bearish investors are comparing present valuations to valuations in the Nifty Fifty or Dot-com bubble eras.
They are wrong. Valuations are nowhere near as high as the Nifty Fifty or Dot-com eras.
Valuations in the Nifty Fifty era
At the end of 1972, the S&P’s P/E was just under 20. Meanwhile, the Nifty Fifty’s average P/E was 41!
- Polaroid had a P/E ratio of 90.
- Disney had a P/E ratio of 82.
- McDonalds had a P/E ratio of 85.
These were all large cap “growth” companies at the time, yet they still had sky-high valuations. You can see that by comparison, the valuations of FAANG stocks today aren’t that high. Many FAANG stocks like Google, Facebook, and Microsoft only have P/E’s in the low-30’s.
*In the ensuing 1973-1974 bear market, many Nifty Fifty stocks fell 70%, 80%, or 90%. The market overshoots in both directions.
All the comparisons of today to the dot-com era are wrong. Large cap valuations today are nowhere near as high as they were at the bull market’s top in March 2000.
*We’re only referring to publicly traded companies.
- Yahoo had a P/E ratio of 420.
- Dell had a P/E ratio of 56.
- Sun Microsystems had a P/E ratio of 85.
- Oracle had a P/E of 102.
- Cisco had a P/E of 127.
- Microsoft had a P/E of 55.
- Aol had a P/E ratio of 400.
The next bear market
Investors shouldn’t be concerned right now because a bear market is not on the horizon.
The most overvalued stocks will crater the most in the next bear market. The long term historical average for an individual stock price is a P/E ratio in the mid-teens. But remember 2 things:
- The long term historical “average” is merely an average! In a bear market, P/E ratios fall far below the average.
- Earnings fall in bear markets as well. Hence, the stock price needs to fall much more than earnings in order for the P/E ratio to fall.