As Big Tech goes, so goes the market.
That’s been the dominant theme for years, and that’s the story of the recent selloff and mini-bounceback that followed. After the brief span just before Labor Day weekend, when all of the ten most valuable members of the Nasdaq hit all-time highs, the group dropped 7.2% by the close on September 15 close, shedding $700 billion in market cap from their peak. Though the vast majority of stocks––including beaten down financials and airlines––proved resilient over that period, their numbers and strength weren’t nearly sufficient to offset the drag from the falling tech titans. It’s Big Tech that wields the power.
Naturally, Big Tech’s retrenchment has heightened the debate over whether its leaders are vastly overpriced and long overdue for a steep slide, or simply suffering a temporary stumble. Indeed, the group has rebounded since the initial drop in early September, showing that the Apples and Teslas may once again be on the march. Given that its marquee names pretty much set the market’s direction, let’s examine what Big Tech’s past trajectory tells us about where where the group is headed.
Five years ago, Big Tech if not cheap, looked modestly priced
For this analysis, we’ll study the ten highest-market-cap tech companies in the Nasdaq 100. That’s actually 11 stocks, since the Nasdaq counts both Alphabet’s A and B shares separately. We’ll treat the entire group as a single company I’ll label “StarTech,” and see how its price, profits, dividends and buybacks have changed over the past five years, and what those changes mean for handicapping StarTech’s future.
To best compare today’s StarTech to its past versions, I look at its metrics on September 30 each year from 2015 to 2019, and those numbers as of September 15 of this year. These benchmark’s are based on performance from the start July to the end of June, since results for the September quarters were not yet available at the end of that month. Fortune‘s statistical wizard Scott DeCarlo provided me with lists of the Nasdaq’s tech Top Ten (our StarTech), including their market caps and earnings, on those dates. Our chosen name StarTech recalls a beloved sci-fi TV series, and it’s remarkable that the top cast in both StarTech and Star Trek remained pretty much the same over the years, though for StarTech, the supporting players changed substantially.
At the end of Q3, 2015, StarTech encompassed, from high to low as measured by market cap, Apple, Alphabet, Microsoft, Facebook, Amazon, Gilead Sciences, Intel, Cisco, Amgen and Celgene. At the time, future members Tesla and Nvidia didn’t come close to making the cut, ranking 35th and 78th respectively on the Nasdaq 100. StarTech’s total market valuation then was an almost quaint $2.688 trillion. We’ll treat that number as its “share price.” Several of its components looked like screaming buys, with Apple featuring a price-to-earnings multiple of 13, and Microsoft at 17, Gilead at 10, and Intel at 13. All told, StarTech amassed $141 billion in GAAP net earnings over the trailing four quarters (July to June), and hence harbored a P/E of 19.1. Talk about retro.
Over the past four quarters ended in June 2015, StarTech paid out $27.4 billion in dividends led by Apple and Microsoft. That put its dividend yield at 1.5%. In a sign of things to come, it lavished almost three times that much, another $71.8 billion, on share repurchases. So StarTech was returning $99.2 billion, or 70% of total earnings, to investors. Because its P/E was a relatively modest sub-20, StarTech delivered a return of 3.7% in dividends and buybacks alone ($99.2 billion divided by its “price” of $2.688 trillion). That dividend-plus-repurchases yield provided a solid foundation for future gains, a foundation that’s crumbled since. On top of that 3.7%, investors could expect extra juice from gains in earnings, and a perhaps a rising P/E, since its then-benchmark of 19 appeared to leave room for expansion. As we’ll see, it was the moonshot in the P/E that put StarTech in its current box.
Over the next four years, the supporting cast changed, and StarTech got pricier
Three years later, on September 30, 2018, StarTech encompassed exactly the same businesses save two: Nvidia and Netflix replaced Gilead and Celgene. By then, its “price,” or total market cap, had jumped 123% to $6.0 trillion. Having two big biotech earners supplanted by newcomers with giant P/Es helped render StarTech a lot more expensive. Although earnings rose 36% to $194 billion, the much bigger jump in its price raised the P/E by two-thirds, to 31.
Surprisingly, over the following year StarTech’s momentum stalled. By the end of September, 2019, less than a year ago, its valuation stood a tad lower at $5.948 trillion, while earnings rose 18% to $228 billion. All of a sudden, StarTech was looking, if not like a bargain, somewhat more reasonably priced. The reason is two-fold. First, Apple was supplying a base of huge, though slowly growing profits, and Google and Facebook provided earnings that were both increasingly big, and racing ahead. Plus, Intel, Cisco and TI, big profit-makers with relatively low P/Es, were still part of the mix, contributing lots of earnings relative to their valuations. The pause, however, was just the prelude to an explosion in prices not witnessed since the bubble of 2000.
It’s just in the past year that StarTech’s went stratospheric
In just over 11 months, StarTech’s has entered territory that medieval cartographers labeled, “Here Lie Dragons.” On September 15, its market hit $9.42 trillion, a $3.47 or 58% increase over September of 2019. By contrast, earnings dropped 8% to $209 billion. That’s because profits for Microsoft and Alphabet declined, Apple’s barely grew, and the addition of Tesla for the first time, and replacement of Intel, Cisco and TI (by Nvidia, PayPal and Netflix) added huge market caps but puny profits.
The upshot: StarTech’s P/E surged from 26 to 45. Investors are now paying 130% more for each dollar of earning than in 2015, when it’s multiple was just 19.
Basic math says that StarTech won’t make you money from here
StarTech’s overall profits actually performed pretty well since 2015, rising from $145 billion to $209 billion, or 44%, a pace of 7.8% a year. What’s capping the upside, and threatening a drop, is the rampaging price that’s waxed three times as fast as profits.
Today, StarTech’s being managed a lot more conservatively than in 2015, as shown by the share of earnings it’s distributing instead of re-investing. That contradicts its fans portrayal of Big Tech as a matchless growth machine. From mid-2019 to mid-2020, StarTech paid $30 billion in dividends, amounting to 14% of profits. The big money went to buybacks; StarTech spent an estimated $138 billion in repurchases over those twelve months, so all told, it returned 80% of total profits to shareholders, versus 70% in 2015. While it plowed back $3 of every $10 in earnings to grow the business five years ago, that number shrank to $2 by 2020.
Even though it’s distributing a lot more cash, StarTech is offering a far lower juice from buybacks and dividends for a simple reason: Its price has more than tripled. Its dividend yield has fallen from 1.0% to .32%, while the kick from repurchases has dwindled from 2.7% to 1.5%, halving the total yield provided by both from 3.7% to 1.8%.
A 1.8% return from dividends and buyback pales beside the kind of double-digit gains that fans have been garnering from Big Tech, and that they expect in the future. By implication, the believers are saying that these vaunted names will generate enormous returns on the 20% of earnings they’re keeping to grow the business. It’s not encouraging that they’re essentially admitting they have no profitable places to invest the other 80% of their earnings.
Let’s make the optimistic forecast that total StarTech’s total profits will rise at 6% a year over the next half-decade. That’s well below the 7.8% since 2015. But keep in mind that it’s reinvesting a share of its profits that’s ten-points lower. In addition, the group will continue to be dominated by stalwarts that are either mature (Apple, Microsoft), or getting there fast (Alphabet). And achieving 6% earnings growth means that StarTech will need to generate 20%-plus returns on the dollars it channels into new plants, fabs, and acquisitions.
Getting there means StarTech must raise profits from $209 billion to $279 billion by mid-2025. If that happens, investors would pocket a decent annual total return of 7.8%, 6% from increasing profits and 1.8% from dividends and buybacks. But those numbers incorporate a hugely positive assumption: That StarTech’s P/E remains at its current, highly elevated level of 45. The selloff brought that number down from 50 at the peak on September 2.
A multiple of 45 is seventy-five percent higher than the 2015 to 2019 average benchmark of 25.8. So prudent investors should ask what would happen if StarTech’s P/E fell to 30, which is still 16% above the five-year norm. In that case, its market cap would fall from today’s $9.42 trillion to $8.37 trillion, or 11%. But investors would benefit from a shrinkage in shares outstanding courtesy of all the buybacks, which would cut the count by around 12%, although it’s important to note that newcomers Tesla and Netflix are floating more shares to expand their franchises. So the 11% drop in the valuation would leave investors with a 1% annual capital gain. The reason: Though the total market cap would be 11% lower, the price per share (because there’s 12% fewer of them), would still be 1% higher. Add the .32% dividend yield, and the total return would be just under 1.5%.
Those aren’t the sumptuous gains big tech partisans are counting on. A 1.5% return loses to inflation. If the P/E drops back to its mid-20s average, those potential returns would to go zero or turn negative.
Of course, one scenario could bail out StarTech, and maybe it’s the one the zealots are counting on. They’re placing gigantic expectations on newcomers Tesla, Nvidia, Netflix, Adobe, and PayPal, not to mention Amazon, a gang of five that’s selling at 114 times earnings. Few groups in stock market history have been accorded such great expectations. For StarTech to pay off, they’ll have to deliver not just big, but bigger than big. That’s the problem. What’s great about StarTech isn’t its performance. It’s the expectations.
