It has been a rough few months for U.S. stocks but even rougher for shares of technology companies. The widely followed and tech-heavy Nasdaq Composite Index is down about 30% since it peaked in November.
Investors may be wondering whether tech stocks are a bargain. The answer is no: They're a lot cheaper but not cheap yet.
One way to measure tech's decline is to track how much valuations have contracted. The Nasdaq's forward price-earnings ratio — that is, the P/E ratio based on analysts' earnings estimates for the current fiscal year — has tumbled to 24 from 42 at the end of 2020, a 43% haircut.
While that's a big move, it merely brings the Nasdaq in line with its historical average P/E ratio back to 2001, the longest period for which numbers are available.
And tech stocks can get a lot cheaper.
For most of the 10 years from 2008 to 2017, the Nasdaq's P/E ratio was below that average, and often well below. It dipped to 13 during the 2008 financial crisis, and it hovered around 14 or 15 for a good part of 2011 and 2012.
That's still a long way from where the Nasdaq trades now. It would need to decline an additional 40% to reach those levels, assuming analysts' earnings estimates for this year are reliable.
If profits come in weaker than expected, the decline would have to be even steeper for the Nasdaq to revisit its historical lows.
The analysis is the same even after accounting for the fact that tech companies command higher valuations. While the Nasdaq's forward P/E ratio has always been above that of the S&P 500 Index, the extent of the premium has varied and it, too, is down considerably.
