Are Large-Cap Stock Bubbles About to Start Bursting?

Have traders forgotten about the dot-com bubble bloodbath?

May 31, 2014 at 9:30AM

The history of the stock market is filled with bubbles that inflate and burst. In a free-market economy, this phenomenon is fairly common. Most recently, the U.S. housing bubble of the early 2000's wreaked havoc on the economy when it started to burst around eight years ago. In hindsight, these bubbles often seem so obvious that it is mind-boggling that nobody seems to notice them forming in real time. Of course, the handful of people who do see the bubbles forming can make some major money when they burst. Today I'd like to take a look at three large-cap stocks that might currently be experiencing bubbles in share price: (NASDAQ:AMZN), Adobe Systems (NASDAQ:ADBE), and Netflix (NASDAQ:NFLX).

Exceptional circumstances
Long before the housing bubble, way back in the prior millennium, enthusiasm for the monetary potential of the Internet laid the groundwork for the dot-com bubble. One key element of most bubbles is the belief in the exceptionalism of the circumstances. In the late 1990's, investors believed that the Internet would become such a cash cow that they flocked into any stock with a "dot-com" attached to its name. At the time, investors completely disregarded traditional stock valuation metrics such as the price-to-earnings ratio, or P/E. The belief was that the connectivity and access to information that the Internet would provide was going to lead to an era of economic opportunity that the world had never seen before.

The Internet has certainly provided unprecedented financial opportunity. However, the prominent belief at the time seemed to be, "It doesn't matter how expensive stocks are because the Internet is the exception to the lessons that history has taught us about stock valuation." This belief in exceptionalism is always a dangerous belief to hold.

The ghosts of bubbles past
In March of 2000, Jeremy Siegel wrote an article for the Wall Street Journal entitled "Big-Cap Tech Stocks Are a Sucker Bet." In the article, Siegel challenged the belief that Internet stocks were the exception to the rules of the market by noting that "many of today's investors are unfazed by history -- and by the failure of any large-cap stock ever to justify, by its subsequent record, a P/E ratio anywhere near 100."

Siegel focused on companies with extremely high P/E ratios at the time, such as Nortel Networks (1999 P/E of 105.6), Cisco (1999 P/E of 148.4), and Yahoo! (1999 P/E of 119.0). Nortel filed for bankruptcy in 2009. Cisco and Yahoo! survived the burst of the bubble, but the stocks each took major hits. In January 2000, Yahoo! shares reached $118.75, but subsequently plunged 93% to $8.11 by September 2001. In March 2000, Cisco briefly became the world's largest company by reaching a market cap of $555.4 billion. 


By 2001, Cisco's market cap was only $151 billion. Now, nearly 14 years later, Cisco's market cap is $124.6 billion.

This time it's different... right?
Shareholders of Netflix, Adobe, and/or Amazon are probably well aware of the multiples at which these stocks currently trade. Defenders of these companies argue that high growth rates justify these otherwise ridiculous P/E ratios. There's no arguing that these three companies are rapidly growing, but so was Cisco in 2000. One of Siegel's main points was that once a company reaches large-cap size, it becomes increasingly difficult for it to grow at such a high rate. However, assuming that these companies actually grow their earnings at their current projected five-year growth rates (according to, what will their P/E ratios look like in five years?

Company Current P/E 5-yr growth rate

P/E in 5 yrs

Amazon 476.4 46% 73.0
Adobe 357.0 18% 52.1
Netflix 147.3 35% 32.8

The answer: not great. However, here's the kicker: these projected P/E ratios assume a 0% change in share price over the next five yearsSiegel made similar projections for the companies mentioned in his article and assumed investors were expecting 15% annual returns from these types of high-growth stocks. Assuming 15% annual returns in share price produces the following projected P/E ratios five years from now:

Company Current Price Current P/E Price in 5 yrs P/E in 5 yrs
Amazon $304.91 476.4 $613.28 146.74
Adobe $63.15 357.0 $127.02 104.76
Netflix $391.80 147.3 $788.05 66.07

Again, those are some pretty ugly ratios.

Time to panic?
Just because a stock is trading at a high P/E ratio doesn't necessarily mean that a crash is imminent. For example, Netflix's P/E ratio has been over 100 since late 2012, and the share price has risen steadily since that time. Also, I'm not suggesting that Netflix, Amazon, and Adobe are terrible companies, no more than Cisco and Yahoo! were terrible companies back in 2000.

However, if you are a shareholder of these three companies or any other large-cap stock with a P/E over 100, you need to ask yourself these two questions: Is the astronomically high growth rate that is required to justify the current share price a reasonable growth rate to expect for such a large company? Is my company truly the exception to Jeremy Siegel's observation that no large-cap companies have ever justified this high of a multiple? 

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Wayne Duggan has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems,, Cisco Systems, Netflix, and Yahoo. The Motley Fool owns shares of and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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