The new tech bubble

January 14, 2002: 4:23 p.m. ET

Tech stock valuations are higher now than they were before the bear market began two years ago.
By Staff Writer Paul R. La Monica

NEW YORK (CNN/Money) - Tech investors seem to have found some wormhole in the space/time continuum. That's the only way to explain the sector's performance in the past four months.

The Nasdaq is up 42.1 percent since Sept. 21 and tech stocks are once again grabbing all the market headlines. Investors ate up bullish comments from Cisco and Oracle last week. It's as if we've been flung back to those heady days of 1999 and early 2000 -- in more ways than you may think.

More expensive than March 2000
Even though the Nasdaq is still down nearly 60 percent from its March 10, 2000 apex of 5,048.62, valuations for the technology sector are disturbingly starting to creep up again.

In fact, the S&P Technology Index is now trading at a higher price to earnings multiple (using earnings estimates for the next four quarters) than it did just before the tech bubble burst. According to Thomson Financial/First Call, the S&P Technology Index is trading at 48 times earnings estimates for 2002, compared to a P/E of 46.7 in March 2000.

Tech bulls would argue that these rich valuations are justified because technology earnings growth is expected to well outpace growth for the overall market. Analysts expect earnings to increase by 46 percent this year while earnings for the S&P 500 are estimated to grow by just 15.8 percent.

Technology stocks have historically traded at a premium to the overall market because of higher growth expectations. According to data from Thomson Financial/First Call, the average forward P/E ratio for the S&P Technology Index since 1985 is 18.3 while the average for the S&P 500 is 15.2 -- a 20 percent premium.

The premium in March 2000 was 107 percent. And now? 114 percent.

� This is hard to swallow, especially since some think earnings estimates for the technology sector are too high. If estimates are lowered, that makes these already rich earnings multiples even frothier. It also is hard to justify these valuations since, as the accompanying table shows, fundamentals for many widely-held technology stocks have deteriorated over the past few years.

Growth rates have come down sharply
Though overall P/Es are higher, many well-known tech stocks are looking cheaper. But appearances can be deceiving. Dell, trading at 39 times estimates for its next fiscal year, may seem like a bargain since the company traded at nearly 57 times forward estimates on March 10, 2000. But Dell's (DELL: down $0.85 to $28.10, Research, Estimates) long-term estimated growth rate back then was 31.7 percent and has been since slashed to 15 percent. So using the PEG ratio, which is calculated by dividing the price to earnings ratio by a stock's estimated long-term growth rate, Dell is now trading at 2.6 times its growth rate, compared to a PEG of just 1.8 on March 10, 2000.

Beaten down JDS Uniphase may look like a steal at less than $10 a share. But the company is still trading at 180 times next year's earnings estimates and at 7.2 times its growth rate, higher than its PEG of 5.4 at the Nasdaq's peak. Analysts are predicting earnings growth of 25 percent annually now for JDS Uniphase (JDSU: down $0.50 to $8.18, Research, Estimates), compared to projections of 46.6 percent back in March 2000.

Intel's stock is 42 percent lower than it was on March 10, 2000. Yet Intel (INTC: down $1.05 to $33.48, Research, Estimates) is trading at 3 times its growth rate, compared to a PEG of 2 back in March 2000 as its estimated growth rate has slipped from 20.4 percent to 18 percent. And Microsoft, trading at 31 percent below its March 10, 2000 stock price, is slightly more expensive on a PEG basis, trading at 2.5 times its growth rate compared to 2.4 before the Nasdaq began its long descent. Microsoft's (MSFT: down $3.76 to $66.10, Research, Estimates) growth rate has fallen from 24.8 percent to 15 percent.

Clearly, technology still has higher growth potential than other market sectors. But given the huge run-up in the last few months, investors will need to be even more careful than usual. Finding companies trading at lower valuations than they did before the Nasdaq tanked will be key. And most of the blue chip tech companies don't fit that definition.