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Portfolio > Portfolio Construction > Investment Strategies

Tech Stocks Are in a Bear Market, But They Aren’t Cheap

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It has been a rough few months for U.S. stocks but even rougher for shares of technology companies. The widely followed and tech-heavy Nasdaq Composite Index is down about 30% since it peaked in November.

Investors may be wondering whether tech stocks are a bargain. The answer is no: They’re a lot cheaper but not cheap yet.

One way to measure tech’s decline is to track how much valuations have contracted. The Nasdaq’s forward price-earnings ratio — that is, the P/E ratio based on analysts’ earnings estimates for the current fiscal year — has tumbled to 24 from 42 at the end of 2020, a 43% haircut.

While that’s a big move, it merely brings the Nasdaq in line with its historical average P/E ratio back to 2001, the longest period for which numbers are available.

A Bloomberg chart labeled Not Cheap Yet that shows Tech stocks are trading near their long-term average valuation.

And tech stocks can get a lot cheaper.

For most of the 10 years from 2008 to 2017, the Nasdaq’s P/E ratio was below that average, and often well below. It dipped to 13 during the 2008 financial crisis, and it hovered around 14 or 15 for a good part of 2011 and 2012.

That’s still a long way from where the Nasdaq trades now. It would need to decline an additional 40% to reach those levels, assuming analysts’ earnings estimates for this year are reliable.

If profits come in weaker than expected, the decline would have to be even steeper for the Nasdaq to revisit its historical lows.

A Bloomberg chart labeled Room to Move showing technology stocks have been a lot cheaper relative to the broad stock market than they are today.

The analysis is the same even after accounting for the fact that tech companies command higher valuations. While the Nasdaq’s forward P/E ratio has always been above that of the S&P 500 Index, the extent of the premium has varied and it, too, is down considerably.

The ratio between the Nasdaq and the S&P 500’s forward P/E ratios is now 1.4, down from 1.6 at the end of 2020. But that’s also roughly in line with the historical average and well above the lows. The ratio dipped down to 1.1 as recently as 2016.

Another way to tell whether tech stocks have neared bottom is if they start showing up in value indexes. Index providers define value differently, but a common denominator is valuation.

Facebook parent Meta Platforms Inc., at 14 times forward earnings, is already cheaper than prominent value stocks Berkshire Hathaway Inc., Johnson & Johnson, UnitedHealth Group Inc. and Procter & Gamble Co., the cheapest of which trades at 17 times and the others above 20. Google parent Alphabet Inc., at 18 times, is cheaper than all but Johnson & Johnson.

A Bloomberg chart labeled Changing Stripes showing that Longtime growth stocks Google and Facebook are now cheaper than many value stocks.

But many other former highflyers have further room to fall. Notably, even after a 44% decline from its 52-week high, Inc. still trades at 49 times forward earnings, and Tesla Inc. trades at 61 times despite a decline of 41%.

That doesn’t mean tech stocks will fall further, obviously, and investors looking for discounts in tech will find them aplenty.

Indeed, those who liked tech stocks six months ago should love them now. But investors who are buying tech believing that the lows are in should take another hard look at the numbers.


Nir Kaissar is a Bloomberg Opinion columnist covering markets. He is the founder of Unison Advisors, an asset management firm.

(Image: Chris Nicholls/ALM)

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