Tech stocks are in a bear market, but they’re not cheap

The past few months have been tough for US stocks, but even tougher for tech stocks. The widely followed and tech-heavy Nasdaq Composite Index has fallen about 30% since peaking in November. Investors may be wondering if tech stocks are a bargain. The answer is no: they are much cheaper but still not cheap.

One way to measure the decline of technology is to track how much valuations have contracted. Nasdaq’s forward price-to-earnings ratio, i.e. the P/E ratio based on analysts’ earnings estimates for the current fiscal year, fell from 42 to 24 at the end of 2020, a discount of 43%. While this is a significant change, it simply brings the Nasdaq back to its historic average P/E ratio in 2001, the longest period for which numbers are available.

And tech stocks can get a lot cheaper. For most of the 10 years from 2008 to 2017, the Nasdaq P/E ratio was below this average, and often much lower. It fell to 13 during the 2008 financial crisis, and it hovered around 14 or 15 for much of 2011 and 2012. That’s still a long way from where the Nasdaq is currently trading. It would need to fall another 40% to reach those levels, assuming analysts’ earnings estimates for this year are reliable. If earnings are weaker than expected, the decline should be even steeper for the Nasdaq to return to all-time lows.

The analysis is the same even after taking into account that technology companies are showing higher valuations. Although the Nasdaq’s forward price-to-earnings ratio has always been higher than that of the S&P 500 index, the magnitude of the premium has fluctuated and it too has declined significantly. The ratio of Nasdaq to S&P 500 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 hollows. The ratio fell to 1.1 as recently as 2016.

Another way to tell if tech stocks have bottomed out is if they are starting to show 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 major value stocks Berkshire Hathaway Inc., Johnson & Johnson, UnitedHealth Group Inc. and Procter & Gamble Co., whose the cheapest is trading at 17x and the others above 20. Google parent Alphabet Inc., at 18x, is cheaper than all but Johnson & Johnson.

Lee J. Murillo