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At 3000, the Nasdaq Is No Bargain

In a move befitting Leap Day, the Nasdaq Composite briefly jumped above the 3000 mark Wednesday for the first time since the 2000 dotcom stock bubble. How soon might it retake its all-time high of over 5000?

Not particularly soon, the numbers suggest.

The Composite, which reflects the broad Nasdaq stock market, remains loaded with computer stocks. They account for 45% of the index. Apple in particular is 11%. The largest seven companies are all computing concerns–eight if we count Amazon (AMZN).

Late last year, U.S. stocks looked moderately priced relative to earnings, and technology stocks looked like a relative bargain within the U.S. market. But this year through Tuesday, the S&P 500 index returned 9.5%–as much as it historically returned in a full year, on average. The S&P’s tech sector returned 16% year-to-date, much of it owed to a run-up for Apple.

The Nasdaq Composite jumped 15% this year.

One way to tell whether the Nasdaq is expensive is to look at the ratio of share prices relative to company earnings. The largest 20 companies, which account for nearly half of the index’s return, trade at a median of 16 times trailing earnings. Among the largest 50 companies, the median is about 20. The historic average for U.S. stocks is below 15.

Earnings typically grow over time, of course, so shares tend to look less expensive relative to earnings forecasts. Standard & Poor’s publishes more extensive data on index earnings forecasts than Nasdaq. Earnings underlying the S&P 500 are expected to grow 6% this quarter, year over year. That’s down from 16% growth a year earlier. And forecasts have been steadily declining in recent weeks, according to Howard Silverblatt, senior index analyst at S&P.

The good news is that the outlook is a bit brighter for the tech sector. Its earnings are projected to grow 10% in the current quarter, year over year. If that forecast holds, and if such a zippy pace proves sustainable in coming years, Nasdaq Composite investors can probably expect high single-digit yearly returns. At that rate, the index might see 5000 by the end of the decade.


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