FORTUNE -- One of the tenets of smart investing is to avoid becoming excessively concentrated in a group of extremely expensive stocks. Anyone who’s enthralled by the big returns in the Nasdaq over the last 18 months, and thinks the recent selloff is a buying opportunity, is making precisely that mistake. And you may not know it, but your share of overpriced merchandise is only getting worse.
It’s true that the Nasdaq is faring far worse than the two other marquee indexes. While the S&P 500 (spx) and the Dow Jones Industrial Average (indu) are hovering near all-time highs, the Nasdaq Composite (comp) -- since reaching a 14-year high of 4371 on March 6 -- has tumbled 6%. That decline has done nothing to correct the Nasdaq’s major drawback: the enormous portion of an investor’s money that a Nasdaq Composite or Nasdaq 100 index fund allocates to a few, generally glamorous big-cap stocks. Stocks, it should be said, that need to perform brilliantly if the exalted expectations of investors are to be met.
The Composite and the 100 are cap-weighted, meaning that the bigger a company’s valuation, the higher its percentage weight in the index. If you own a Nasdaq fund, you’ve now got half of your money in a handful of pricey biotech, social media, and Internet stocks that spike your portfolio with risk.
Let’s look at the weighting of heavyweight companies in those two industries. In the case of Internet and social media stocks, we’ve got Apple (aapl), Amazon (amzn), Facebook (fb), Google (goog), Yahoo (yhoo), and search engine Baidu (bidu) of China. The major biotech players are Amgen (amgn), Biogen Idec (biib), Celgene (celg), Gilead (gild), Mylan (myl), Regeneron (regn), and Vertex (vrtx).
The total capitalization of the Nasdaq 100, consisting of the 100 highest-valuation stocks in the Nasdaq universe, is $3.16 trillion. The 13 companies above account for nearly 50% of the 100’s total valuation, or $1.57 trillion. So one in two dollars in a Nasdaq fund sits in a small group of Internet/social media and biotech names.
The balance has gotten far more lopsided since the start of 2013. At that point, Google hadn’t joined the Nasdaq, and the remaining dozen stocks represented 43% of the Nasdaq 100’s total value. Since then, those companies have performed slightly better than the overall index, rising 39%, vs. 37% for the 100, and hence increasing their share just a bit. The arrival of Google on March 27 brought the group’s share up to almost half of the Nasdaq 100’s value.
So why is having so much of your money in a few high-flyers so hazardous? The answer, in part, is because the market has outsized expectations for these bold-faced names. And if they fall short -- a strong possibility, it would seem -- shareholders will get severely punished.
Shares in most of these companies, indeed, have fallen sharply since the Nasdaq reached its peak in early March. (A big gain in Apple pretty much offset the losses at the likes of Facebook and Amazon, so the fall wasn’t as jarring as it could have been.)
Secondly, the Big 13 may not be as big as investors think. While the group accounts for nearly half the market-cap weight of the index, total sales for these companies comprise 25% of the Nasdaq 100’s revenues. The profit picture is also somewhat deceiving. The overall price-to-earnings ratio of our club of 13 is 20, based on four quarters of trailing, reported profits. While that’s hardly cheap, it might be construed as fairly reasonable. The issue is that Apple alone accounts for over 70% of the group’s total profits. For the remaining 12, the combined P/E stands at a staggering 40.
So to put your money on the Nasdaq 100, you’d need to believe that Apple’s earnings will keep growing modestly from today’s record level of $46 billion, and that all the other companies will fulfill the market's epic expectations. In short, you're betting that the 40 P/E won't collapse like a soufflé if (or when) the hoped-for, gigantic earnings growth fails to materialize.
How should I put this? That's sweet in its naiveté.
Sure, the Nasdaq has been a great momentum play and, sure, the momentum could resume. But as we all learned in 2001, even the greatest of bashes doesn’t last forever.