In a week that saw three tech companies float on the Nasdaq and New York Stock Exchange, Wall Street analyst Bernstein is mulling the potential of a share price crash based on similar indicators prevalent during the .com bust.
Sumo Logic listed 14.8 million shares on the Nasdaq at $22, and JFrog debuted on the same exchange with 11.6 million shares priced at $44. However, it was Snowflake’s $33bn flotation on the NYSE that raised eyebrows: it turned over $348.5m in the year ended 31 January and reported a loss of $178m. There are, of course, other factors to consider aside from financials, there is potential – but still.
Bernstein said there are “myriad similarities” between the current situation and the .com bubble that burst in March 2000 – with presumably even the Queen getting soaked – when the NASDAQ index shrank 67 per cent in the following nine months.
Seven of the nine big tech businesses at that time – including Cisco, Intel, Oracle, Hewlett Packard, Nortel, Lucent, Sun Microsystems, and Hewlett Packard – “never surpassed their peak market cap achieved in 2000 again,” said analyst Toni Sacconaghi.
“While Microsoft and IBM ultimately were able to eclipse their peak bubble valuations, it took each company more than 12 years to do so,” he added.
So why is the great rally of 2020 analogous with the crash all those years ago? Sustained outperformance of tech shares for eight years is one factor, said Bernstein, “driven by superior earnings growth; however and most importantly, that has changed with tech’s relative multiple expanding materially (38 per cent) in the last three years.”
Other major considerations are that the top 12 tech stocks have swelled 170 per cent in value in the past 12 months compared to 146 per cent before the 2000 pop. And the tech sector’s percentage of the top 1,500’s entire market cap is 37 per cent, which is “eerily similar to the peak of the 2000 bubble”.
As was highlighted by Snowflake’s valuation, the number of businesses operating in the red is worryingly close to two decades ago too. “The percentage of unprofitable tech companies today is high versus history (32 per cent), and not dramatically different [to] that in March 2000 (36 per cent),” said Sacconaghi.
Tech companies account for half of the top 10 stocks, and 24 per cent of the S&P – a stock market index used as a metric for the share performance of the 500 largest companies on US exchanges – while the top 10 in total account for 29 per cent. This compares to 16 and 24 per cent respectively in the year 2000.
“Most notable to us is the valuation spread between the most expensive vs the least expensive tech stocks, which is similar to March 2000,” Sacconaghi said.
“Signs of mania associated with a bubble are also appearing – high profile stocks such as Apple and Tesla have seen enormous appreciation following stock splits; retail flows and interest among investing neophytes in the market appears to have increased dramatically, enabled by low cost trading platforms and fractional share ownership… akin to what we saw in the bubble as online trading proliferated.”
That said, in the main, valuations today are elevated but “nowhere near the peak of the  bubble”, though they are still trading at their highest level since that time.
Coronavirus has certainly played a part in the soaring demand for hardware and software services. Cloud vendors benefited from lockdown, as did makers of tech that could enable employees to work from home more effectively or students to learn remotely.
“Most recently, market consensus has crowned tech as the clear secular winner amid coronavirus, as tech earnings are currently expected to grow 1 per cent in 2020 while the rest of the market is expected to see earnings fall 20 per cent,” said the stock watcher. “Naturally, this combination of high valuations and high expectations increase the risk for disappointment.”
Bernstein’s most pressing concern is valuation of the top 20 per cent of listed tech firms and said the “fundamentals of tech arguably look better than ever” with software and subscription models being more prevalent.
“Over the last several years, we have seen an unprecedented migration to the growth side of the barbell,” said Sacconaghi. “The strength and sustainability of this growth rally in tech and the broader market is probably the biggest question among investors today. While momentum is a powerful force, we encourage investors to be cautious on expensive names with decelerating growth or low quality scores.” ®