Technology stocks are exhibiting valuation levels reminiscent of the dot-com era, based on a commonly used valuation metric. However, this does not necessarily mean the sector is poised for a decline, according to a team of senior investment strategists at John Hancock Investment Management.
In a commentary emailed to MarketWatch, these strategists noted that the technology sector’s forward price-to-earnings (P/E) ratio recently reached 30.9, its highest level since mid-2002. Back then, the market was nearing the end of a significant three-year selloff in the S&P 500 index following the collapse of the dot-com bubble. This milestone comes after a remarkable period of outperformance for the tech sector. Unlike during the dot-com era, today’s technology stocks have shown strong earnings growth, a trend expected to continue.
Robust Performance and Future Growth
The technology sector is unique in that it has outperformed the S&P 500 over the past five years. This outperformance is bolstered by strong earnings growth, profit margins, and solid balance sheets. In the first quarter, tech stocks saw their earnings per share (EPS) increase by 25%, surpassing Wall Street’s high expectations. Projections indicate that this growth will continue, with an expected increase of 15% for the rest of 2024 and 19% in 2025. A significant contributor to this growth is Nvidia Corp., a leader in artificial intelligence and chip design, which reported a 461% increase in non-GAAP EPS to $6.12 compared to the same period in 2023.
Valuation Comparisons
Even with stellar growth expectations, tech stocks remain expensive relative to the broader market. The sector’s price-to-earnings-to-growth (PEG) ratio stands at 1.39, higher than the S&P 500’s 1.27. The PEG ratio adjusts the price-to-earnings ratio by factoring in expected earnings growth, providing a more nuanced view of a stock’s valuation.
Strategic Recommendations
Given the current high valuations, the John Hancock team advises investors to remain overweight in the technology sector. They argue that high valuations alone are unlikely to prompt a significant selloff without an external shock. However, to mitigate valuation risk, they recommend increasing exposure to high-quality midcap stocks with cheaper valuations. This strategy provides a balanced approach, allowing investors to benefit from the continued growth in the tech sector while reducing potential risks associated with its high valuations.
Comparing to the Dot-Com Era
The current market situation differs significantly from the early 2000s. During the dot-com bubble, many tech companies were overvalued based on speculative growth without solid earnings or profit margins. In contrast, today’s tech companies are characterized by substantial earnings growth, robust profit margins, and strong balance sheets. This financial health provides a buffer against market volatility and speculative bubbles.
The sustained strong earnings growth and financial health of tech companies today offer a more secure investment landscape compared to the dot-com era. By focusing on fundamental metrics such as earnings growth and profitability, investors can navigate the high valuations in the tech sector while safeguarding their portfolios through strategic diversification. The recommendation to diversify into high-quality midcap stocks with lower valuations ensures that investors are not overly exposed to potential market corrections in the tech sector.
In summary, while technology stocks are currently giving off dot-com era vibes with their high valuations, the underlying financial health and earnings growth of these companies provide a more stable investment environment. Investors are advised to remain overweight in the sector while strategically diversifying to manage potential risks.
