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. This article was published June 6 on RealMoney.
The late, great Ben Graham could've been talking about the recent
rally many years ago when he said, "Wall Street people learn nothing and forget everything."
After a once-in-a-generation three-year bear market that saw the Nasdaq lose roughly 80% of its value, it's completely reasonable to expect the index to rally for a year or so. But to say that we've launched a multiyear bull market in Nasdaq stocks is not reasonable. It would mean that investors learned nothing and forgot everything from the bubble years.
One lesson that investors should've learned after the Nasdaq's bubble burst is that prices mean something. It doesn't matter how much hype and promise tech companies proffer; at the end of the day, the proposition for every investor is still one of value.
There's no such thing as a perfectly priced stock. Every stock, without exception, is either overvalued or undervalued -- some by a little, some by a lot. The prudent investor has a simple question to ask when allocating capital: Does price exceed value? Or does value exceed price?
That's the way I approach the marketplace for publicly traded businesses. To the extent a stock price is significantly lower than the underlying business value, I'm interested in allocating capital to the stock. In the case of the Nasdaq, my calculations of the underlying business value at the top 15 companies in the index indicate that, in each and every case, stock value exceeds business value by a wide margin.
In addition to my conclusion that price is greater than value, here are some additional observations from my review of the top 15 companies in the Nasdaq:
Balance sheets are too strong. Though this is counterintuitive, too many well-financed companies are a negative for investors. A torrent of capital during the bubble years created excess capacity and provided companies with exceptional staying power. In a normal cyclical decline, a natural winnowing process purges weak companies, such as those laden with debt, from the competitive landscape. Instead, excess capital still dominates the scene, even in the face of reduced demand.
As a result, we have more than a few desperate companies flailing about in search of a market. Witness
(AAPL) foray into music,
(GTW) sales of LCD television screens and
(GLW) push into the ceramics business for pollution-control devices.
Most leading Nasdaq companies are not shareholder-friendly. I'm not interested in allocating capital to companies that aggressively transfer property from shareholders to employees through excessive stock-option programs. I've written before about
at the top 15 Nasdaq companies.
Free cash flow is low to nonexistent at most leading tech companies. That's especially true when you adjust for share buybacks, which are necessary to prevent dilution from stock options.
Demand for tech is weak. I'd like to see swelling demand in the face of limited supply before I'd get excited about the technology sector, which dominates the Nasdaq index. Instead, I see weak demand coupled with building deflationary pressures, from commoditized hardware platforms, a changing software paradigm (including, for example, open-source programming efforts such as Linux) and fast growth in outsourcing of IT services/programming to India and other countries at a fraction of the domestic cost.