You remember the Pet Rock? Biggish stream pebble, came in a little box, cost five bucks. Maybe your mom wouldn't let you have one -- said it was just a rock, said you could go out back and find one just like it, said there was no way she was going to buy a rock for you. Mom just didn't get it.
Mom might not have understood the kind of money people are willing to pay for tech companies. Of course, every investor remembers the kind of rocket fuel that the big tech jets seemed to run on throughout the 1990s -- 30% and 50% and even 100% earnings rises year after year after year. That kind of hypergrowth told investors they should be willing to pay up for these stocks, and pay they did: Tech-stock prices soared through the roof, culminating in what we all know now as the Nasdaq bubble.
Even now, with Nasdaq 60% below its 2000 peak, tech's getting a substantial premium. But a look at tech earnings expectations next to those of some fairly pedestrian nontech outfits suggests that it will be hard for the tech companies to justify their prices. And that could set tech up for a fall whenever there's bad news, such as Thursday's weak report from
, which had the Nasdaq off 2% early Friday.
Just For Instance
For instance, imagine telling Mom that you just bought
at $34. Analysts say the company is supposed to earn 67 cents a share in 2002, and $1 in 2003. That's strong growth from this year's 53 cents -- but maybe you think the analysts are low-balling, and that things are going to be better. Heck, let's say you think Intel's earnings are going to grow 80% this year, coming in at 95 cents a share.
That's still a bit less than the 97 cents it earned in 1997. Now around this time in 1997, Intel traded at about $17. Even if you believe in our Pollyannaish forecast for Intel earnings, you just bought Intel for twice what investors paid in early 1997.
Maybe the tech investor will try to tell Mom that Intel deserves a heftier valuation these days. Some things really are supportive of higher prices: The
fed funds rate was 5.25% back then compared with today's 1.75%, and the yield on the benchmark 10-year Treasury note was about 6.5% and now it's 4.9%. Lower bond yields make stocks look more attractive by comparison. Mom might agree there's some truth in that.
But she might also say there are a bunch of rocks out back that can be had for a lot cheaper than tech. And since that's the case, investors should be aware that any bad news -- company-specific, economywide or otherwise -- could send tech stocks retreating en masse.
Consider this: Intel's earnings have grown, on average, 6% per year over the past five years. But in 2002, its earnings are supposed to jump 21%. The stock trades at 64 times last year's earnings.
earnings have grown, on average, 31% over the past five years. In 2002 its earnings are supposed to rise 27%. It trades at 18 times 2001 earnings.
This isn't an isolated case. Do a screen for nontech companies in the
S&P 500 that show stronger five-year growth and better 2002 earnings growth expectations than Intel, and that have a
price-to-earnings ratio below 30 (that is, less than half of Intel's). Do that and you come up with 20 companies. And it's not just Intel that's trading at a premium this steep: You can repeat this exercise with practically all your favorite tech companies. There are plenty -- such as
-- that trade at a huge multiple to 2001 earnings
are expected to see earnings deteriorate in 2002.
And we haven't even got into the problem with tech earnings expectations. For tech companies in the S&P, according to Thomson Financial/First Call, analysts expect earnings to grow by 45% in 2002. Most of that growth is supposed to happen in the back half of the year. After declining by 34% in the first quarter from the first quarter last year, earnings are supposed to show a 33% year-on-year gain in the second quarter, followed by a 125% gain in the third and a 108% gain in the fourth.
That's going to be a tough order to fill. Salomon Smith Barney's economists are true believers in economic recovery -- they expect
GDP to be growing at 3.8% by the fourth quarter. But senior economist Steven Wieting thinks that, as a whole, S&P tech earnings are going to slip another 7% in 2002.
There are two components to tech sector earnings, he says. One is cyclical, ebbing and flowing with the economy. That is somewhere near its nadir right now, and, like other cyclical areas of the economy, you can expect it to pick up quickly as the year runs on.
But the other component of tech earnings is tied to capital spending, and that, thinks Wieting, will remain in woeful shape through much of the year. On Wednesday we found out that U.S. companies are operating at only 74.4% of capacity, the lowest utilization rate since 1983. Even as the economy improves, it will take a while for companies to start buying new equipment -- whether we are talking camshaft grinders or spanking new routers. No point in getting new stuff until you start using the stuff you already have.
Carry That Weight
This is not to say that no tech companies will grow rapidly in 2002. "There will be big winners, I have no doubt," says Wieting. "But every winner has to do that much more to cart along the losers."
Those big winners already have some steep valuations. Perhaps
calendar 2002 earnings really will be up 111%. But it's trading at 260 times 2001 earnings. Mom might suggest there are cheaper places to find growth.
And she is sorry, by the way, that she threw away those mint-condition
Silver Surfers you left in the basement. She had no idea.