C.J. Lawrence Weekly Market Comment – Growth Remains Attractive…Comparisons to the “Nifty Fifty” and Internet Bubble Periods Miss the Mark
The sell-off in technology shares at the end of July spurred in a chorus of money managers to suggest that the growth dam had finally broken and to forecast that the performance gap between growth stocks and value stocks would close. Several market pundits cited “excessive” valuations on growth stocks, particularly in technology, as a catalyst for their reversal. But as we’ve noted in previous Weekly Market Comments, growth stock valuations don’t look particularly expensive versus fundamentals and previous cycles, and stocks assigned to the “value” category may not be as cheap as one would expect. On 2019 forecasted earnings, the value-oriented Consumer Staples, Utilities, and Real Estate Sector Indices are trading at higher price-earnings multiples than the S&P 500, while the Industrials, Health Care, and Energy Sector Indices are trading at multiples roughly in line with the market. To be sure, there are plenty of gems to be owned within the value style, and financials and select industrial groups look attractive to us. But while the relative price gap between growth and value has widened over the past few years, the valuation gap has not.
Some growth doubters have likened today’s environment to that of the “Nifty Fifty” period in the 1970s, or to the new economy stock mania in the late 1990s prior to the bursting of the internet bubble. But deeper analysis suggests that those comparisons don’t stand up. The original “Nifty Fifty” was a group of fifty stocks identified in the early 1970s as having high and consistent growth characteristics worthy of long term ownership. The group traded at historically high price-earnings multiples based on the belief that their earnings would continue to grow, and that they could be owned at any price. During periods in 1972, McDonalds’ (MCD) stock traded at 86x earnings per share, and Disney’s (DIS) stock traded at 82x earnings per share! When the Nifty Fifty finally rolled over, critics of the strategy claimed that even strong companies could not generate meaningful earnings growth consistently over long periods of time. But in fact, many of the original Nifty Fifty stocks went on to grow earnings at a rapid pace for decades, and have been good investments for as long. Instead of an earnings-related sell-off, the end to the Nifty Fifty success was more likely driven by the crushing weight of sky-high inflation experienced in the mid and late 1970s that compressed Nifty Fifty valuations and sent stock prices plummeting. Meanwhile in the late 1990s the internet bubble stocks sold off after investors came to grips with the fact that many had unsustainable business models and that others were victims of unreasonable expectations.
The valuation picture for today’s growth stocks versus these two periods is much different. While today’s growth stocks trade at premium multiples to the market, their absolute levels are much lower than those experienced in the 1970s or late 1990s. As a comparison to the original Nifty Fifty, we constructed an index of fifty S&P 500 companies that achieved 10%+ earnings growth in both 2016 and 2017 that are also expected to grow earnings 10%+ in both 2018 and 2019. The average annual earnings growth for this index’s constituents over the four-year period (two reported and two un-reported) is 38%. The average P/E multiple on 2018 earnings forecasts for the same group is 24.1x. This compares to an annual average P/E of 45.2x for the original Nifty Fifty in 1972. Likewise, in 1998 and 1999 multiples on technology stocks soared on the back of euphoria surrounding the evolution of the internet and internet related business models. During that period, companies without earnings, and sometimes without sales, were instead valued based on “eyeballs” and “clicks”. The valuations on real fundamentals were astronomical. Even established technology companies were bestowed internet halos and traded at rich premiums. In 1998 Cisco (CSCO) traded at 117x and Oracle traded at 104x forward earnings estimates! Today, investments in select value names may be warranted, but major shifts in style allocation look suspect based on relative fundamentals. History repeats, but comparisons between today’s backdrop and the Nifty Fifty and internet bubble periods miss the mark.