TCS Daily


In a world of Dow 36,000, where should NASDAQ be?

By James K. Glassman - March 6, 2000 12:00 AM

Ever since Kevin Hassett and I wrote our book on stock-valuation, Dow 36,000 (Times Books), people have been asking me, "Okay, but what about the NASDAQ?" Tech investors want to know how to apply our valuation methods to Internet high-fliers.

In Dow 36,000, we argue that traditional analysis has undervalued stocks -- dramatically. In fact, given historic corporate earnings growth of 5.5 percent and long-term Treasury interest rates in the 6-percent range, we think that the PRP (Perfectly Reasonable Price) for the 30 stocks of the Dow Jones Industrial Average is 100 times earnings. That's right: a P/E ratio of 100, or more than three times the current level.

(By the way, a P/E ratio is the number of dollars it takes to buy a dollar's worth of a company's earnings. In the past, P/E ratios have averaged about 17.)

Thanks to the work of Wharton Professor Jeremy Siegel and others, we now know that over the long-term - 15 years or more - stocks are not riskier than bonds. Therefore, we conclude that stocks should not carry a "risk premium" - that is, an extra return beyond the return of the Treasury bond. Our calculations show that, with a zero risk premium, the Dow should be priced at 36,000, with a P/E of about 100.

That means that bargains abound not just among the blue-chip stocks of the New York Stock Exchange but among the companies listed on the tech-heavy NASDAQ as well. For example, Microsoft may already be the world's most valuable corporation, but it looks to me like a bargain at 60 times earnings. Biotech behemoth Amgen doesn't look too shabby at a P/E ratio of 72.

Now, what about companies with P/E ratios above 100? Should investors avoid them?

Not at all. When we were writing our book, Cisco Systems, the Internet infrastructure giant, was trading at $64 a share and carried a P/E ratio of 85. Recently, it traded at $125 with a P/E well above 100. With some fairly modest growth assumptions, we calculated that the PRP for Cisco is $291 - or more than twice its current price.

Still, while I love Cisco and have no hesitation owning it at today's prices, it is generally a good idea to shy away from companies with triple-digit P/E ratios - especially now, with so many terrific companies carrying P/Es far lower. One of many examples is Hewlett-Packard (like Cisco, a member of the Glassman Technology Top Thirty, or GTTT), at a P/E of 40.

What about companies that have yet to make a profit?

Again, proceed with caution, but don't toss such firms out entirely. Another GTTT stock that I love (and, by the way, own myself) is Digex, with no earnings but fabulous growth prospects as an applications service provider, offering a platform with a wide variety of software to corporations.

As for the NASDAQ Composite Index itself: It's risen by a factor of four in barely two years. Can it continue to rise at a rapid pace? Yes, indeed - though ultimately NASDAQ shares and the market as a whole (as represented by the Dow) will probably rise at roughly the same rate over the next five years. Don't expect NASDAQ 36,000 before Dow 36,000.
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