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If you’re wondering why Big Tech is crumbling, and whether the steep drop makes sense, the best guide is examining what drove their gigantic jump over the past year. Was it a durable improvement in their fundamentals, or runway momentum fueled by pollyanna-ish exuberance? We’ve all heard why these shooting stars really deserve seemingly-outrageous prices: Tech is the only place to find big growth and big gains when bonds barely match inflation. Post-Covid America will need much more of what they’re making for the new work-at-home world. Trillions in cash is parked on the sidelines, and poised to join the parade. The Fed will stop at nothing to keep the markets aloft. These justifications, say the optimists, trump the traditional metrics and explain why tech can keep churning higher.
But reviewing the trajectory of the ten most valuable tech stock suggests something different: a craze destined to end just as the 2000 and 2007 frenzies finished. Put simply, a group of mostly the same titans went from somewhat rich to stunningly expensive in just eleven months, as their prices exploded and their overall results showed zero improvement.
At the close of September 2019, the players counting the highest valuations were, from high to low, were Microsoft, Apple, Amazon, Alphabet , Facebook, Intel, Adobe, PayPal, Netflix, and Texas Instruments. That’s actually 11 constituents because the Nasdaq 100 counts both Alphabet A and B shares separately, but we’ll call the group our Top Ten. (We’ll consider Tesla a tech stock because that’s what its boosters call it, and use that label to justify it lofty valuation.)
At the time, the Top Ten’s total market cap amounted to $6.2 trillion, and accounted for 69% of the Nasdaq 100’s $9.0 trillion. As a group, they’d amassed GAAP net earnings over the past four quarters (from July 2018 through June 2019) of $218.2 billion. The biggest profit contributors were Apple ($53.5 billion) and Microsoft ($38.0 billion), the smallest PayPal ($2.6 billion) and Netflix ($1.36 billion). All told, the Big Ten featured a price-to-earnings multiple of 28.4. That’s well above the long-term average for the Nasdaq 100, but looks reasonable given that our group is packed with superstars, though big earners Apple, Microsoft, and Intel are veterans well past their jackrabbit growth phases.
In just eleven months, the Top Ten underwent an extraordinary metamorphosis. The group changed somewhat: Tesla jumped from nowhere to number 7 as its market cap exploded ten-fold to $465 billion, and Nvidia joined at number eight, while Intel and TI dropped off. But eight of the ten, and all the biggest names, stayed the same. At the summit on September 2, the new Top Ten boasted a total valuation of $10.54 trillion, an increase of $4.34 trillion, or 41%, from the $6.2 trillion mark at the end of the same month last year. Just before Labor Day, they’d captured approximately the same two-thirds share of a Nasdaq 100 that bid up by $7 billion.
What’s remarkable––and troubling––is that while prices rampaged, earnings slept. Today, the four-quarter trailing profits for the Top Ten stands at $210 billion. That’s 3.7% below the $218 billion figure in September of last year. Hence, more than 100% of the 41%, $4.34 trillion rise came from a spike in the prices investors were willing to pay for each dollar of earnings. Over those 11 months, the Top Ten’s overall P/E rose from 28 to 50.2. The stalwarts saw substantial increases in their P/Es, with the Apple going from 19 to 40, Microsoft 28 to 44, and Alphabet 27 to 35. The addition of Tesla at a P/E of over 1000, and towering valuations for PayPal and Nvidia (both around 170x) and Netflix (95x) made the mix a lot richer.
Starting at a P/E of 50.2 means that earnings must grow at an extremely rapid rate to give investors a decent return. Let’s assume the multiple falls to a still-premium-priced 30 in five years. For these stocks to deliver mediocre 5% gains, their earnings would need to rise 16% annually, and more than double from today’s $210 billion to almost $450 billion. If profits were depressed and due for a powerful surge, a P/E of 50 might be reasonable. But earnings were already healthy before the huge run-up, so it’s hardly surprising that they’ve gone flat. Nor does the end of the pandemic promise great times ahead, since tech’s been a standout in the downturn.
The Top Ten didn’t make more money over the past year, they just got far more expensive. Since September 2, the group has shed around $1.38 trillion or almost one-third of that $4.34 trillion gain. Big Tech has bounced back big before, and may rally again. Is this the inevitable reckoning? It’s impossible to tell. What’s certain is that reckoning is inevitable.
