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Will AOL Get Nasdaqed Again? (Part I) Economy and MarketsNasdaq 100By Mark Hirschey November 14, 2000 As I write this, America Online (NYSE: AOL) is trading at $50.90 per share, or 94 times trailing 12-month EPS of $0.54, or 63.6 times the $0.80 per share consensus estimate.
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Date Posted: 2/11/10 16:44:07
Community Perspective
Will AOL Get Nasdaqed Again? (Part I)
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AOL
Nasdaq 100
Economy and Markets
By Mark Hirschey
November 14, 2000
The following perspective was written by a member of the Fool community and regular contributor to our discussion boards. The opinions of the author are not necessarily representative of the opinions of The Motley Fool or its editorial staff.
As I write this, America Online (NYSE: AOL) is trading at $50.90 per share, or 94 times trailing 12-month EPS of $0.54, or 63.6 times the $0.80 per share consensus estimate. Stockholders view this as a fair or cheap price. Others, like me, are waiting for lower prices and a greater margin of safety.
Why? Well, whenever I buy a stock, I'm aware of the firm-specific factors involved, as well as the overall market environment. I have concerns about AOL's ability to sustain rapid EPS growth in the face of declining fundamentals for many of its advertising customers. Let's leave that aside for the moment, and consider AOL's present stock market environment.
I have a simple question: Is the market cheap or pricey (vulnerable)? My answer: Pricey, particularly the techs.
Here's why:
The Nasdaq 100 Index (AMEX: QQQ) is today's reincarnation of the Nifty 50 phenomenon. However, many of today's institutional favorites are relative newcomers with short operating histories, modest revenues, and sparse profits. Another difference is the extraordinary valuation of today's favorites. Nifty 50 stocks sold at an average P/E of 37.3 versus a market multiple of 18.2. In February 2000, the Nasdaq 100 P/E reached 134.7, or roughly 4-6 times higher than P/E ratios typical of DJIA (Index: $INDU) and S&P 500 (Index: $SPX.X) companies. At the same time, the P/E ratio for the Nasdaq Composite reached an average P/E of 245.7, or roughly 6-8 times higher than market-wide averages. It is worth asking if such valuations are indicative of a stock-market bubble.
For both institutional and individual investors, today's "bullet-proof" growth stocks can be found among the largest market capitalization stocks on the Nasdaq stock market, and particularly among the companies included within the Nasdaq 100 Index. Launched on January 31, 1985 with a (split-adjusted) base value of 125, the Nasdaq 100 Index represents the largest and most active non-financial domestic and international issues listed on the Nasdaq Stock Market, based on market capitalization.
As of December 21, 1998 the Nasdaq 100 was rebalanced to a modified market-capitalization-weighted index. Such rebalancing is expected to retain the economic attributes of capitalization weighting, while providing enhanced diversification. To accomplish this, Nasdaq reviews the composition of the Nasdaq 100 on a quarterly basis and adjusts the weight of Index components using a proprietary algorithm, if certain pre-established weight distribution requirements are not met.
The Nasdaq 100 reflects Nasdaq's largest companies across major industry groups, including computer hardware and software, telecommunications, retail/wholesale trade, and biotechnology. Broadly speaking, the Nasdaq 100 includes 100 of the largest non-financial domestic and international companies listed on the National Market tier of the Nasdaq Stock Market.
Eligibility criteria for the Nasdaq 100 include a minimum average trading volume of 100,000 shares per day. In general, companies also must have been seasoned on Nasdaq or another major exchange, which means they have been listed for a minimum of two years. If a security would otherwise qualify to be in the top 25% of the issuers included in the Index by market capitalization, then a one-year seasoning criteria would apply. If the issue represents ownership in a foreign security, the company must have a worldwide market value of at least $10 billion, a U.S. market value of at least $4 billion, and average trading volume of at least 200,000 shares per day. In addition, foreign securities must be eligible for listed-options trading.
The large number of securities in the Nasdaq 100 index makes it an effective vehicle for arbitrageurs and securities traders. Other innovations (like the QQQs) have made the Nasdaq 100 index an attractive investment vehicle for small investors.
By definition, the Nasdaq 100 involves fewer companies and is more narrowly focused than the Nasdaq Composite Index. The Nasdaq Composite Index measures all Nasdaq domestic and non-US based common stocks listed on the Nasdaq Stock Market. Today, the Nasdaq Composite includes 4,896 issues from 4,854 companies. Because it is so broad-based, the Nasdaq Composite is one of the most widely followed and quoted major market indices.
Every security assigned to the Nasdaq Composite Index is also assigned to one of the eight Nasdaq sub-indices (Bank, Biotechnology, Computer, Industrial, Insurance, Other Finance, Telecommunication, Transportation). The determination for assignment to an appropriate sub-index is generally based on Standard Industrial Classification (SIC) codes relative to a company's major source of revenues.
On February 5, 1971, the Nasdaq Composite Index began with a base of 100. Thus, an August 31, 2000 month-end value of 4206.35 for the Nasdaq implies a 4,206.41% compound total return and a 12.6% average annual return for the Index over the 29 years since inception.
While the Nasdaq 100 Index includes 100 large Nasdaq stocks by definition, a relative handful dominate that Index and the overall Nasdaq stock market. The top 5 Nasdaq 100 stocks account for more than one-quarter (29.24%) of the value of this market-value-adjusted Index. Only 16 Nasdaq stocks account for more than one-half (51.36%) of the Nasdaq 100; 33 Nasdaq stocks account for roughly three-quarters (75.18%) of the Nasdaq 100. The top 50 Nasdaq 100 stocks account for 86.85% of the overall Index.
Among the most favored Nasdaq 100 stocks, valuation ratios greatly exceed the P/E ratios observed for similar stock market favorites during the Nifty 50 era. Today's investors commonly accord Nasdaq 100 growth stock favorites P/E ratios that greatly exceed norms established for the Nifty 50. Remember, Polaroid (NYSE: PRD) set the high-water mark for Nifty 50 companies with a P/E ratio of 93.5. Among 79 Nasdaq 100 companies reporting positive earnings per share during the trailing 12-month period, fully 24 sport P/E ratios greater than the 93.5 standard borne by Polaroid in 1972. Another 21 report losses for the most recent period. Thus, when compared with today's growth-stock favorites, Polaroid's P/E of 93.5 would appear quite modest. In fact, 45% of the Nasdaq 100 stocks presently have P/E ratios that exceed the P/E high-water mark set for the Nifty 50 by Polaroid.
When compared using P/E ratios, Nasdaq 100 stocks, as a group, are much more expensive than the Nifty 50. The average P/E ratio for 79 Nasdaq 100 stocks reporting positive earnings during the trailing 12-month period is a whopping 131.2, or more than 3.5 times greater than the Nifty 50 average P/E of 37.3. Of course, such averages can be skewed upward by a few very high P/Es for a handful of very low profit Nasdaq 100 companies. However, according to monthly market statistics and information provided by the NASD, the Nasdaq 100 sports a P/E ratio of 93.5, when market values and earnings are considered, for both profitable and unprofitable component companies. Therefore, as a group, present P/E valuation ratios for the Nasdaq 100 exceed the highest P/E ratio accorded to Polaroid or any other member of the Nifty 50.
[This article continues with Part II.]
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