8 pricey stocks haunting the Nasdaq

April 11, 2014: 3:52 PM ET

Problem underscores a glaring weakness in cap-weighted indexes

FORTUNE -- The Nasdaq boosters can't be kept down: The recent selloff, they insist, is a frenzied overreaction that's serving up even better buys. On April 10, the Nasdaq composite index fell 130 points, or 3.1%, marking its largest one-day loss since Nov. 9, 2011, when it fell 3.9%.

The sharp re-pricing is well-deserved. Over time the Nasdaq will careen through spikes and valleys as usual, but the overall trajectory should be downward. In fact, the big losers in the sudden rout are precisely the stocks that grew into the most extravagantly expensive corner of the index. That group, more than any other, made the Nasdaq soar. Now it's a millstone.

The wildly overpriced stocks fall into two main areas, social networking and biotech. Let's examine the fantastic run experienced by eight companies in those categories. They're mostly the ones with the highest market caps: In social networking, the group comprises Facebook (FB), Google (GOOG), and Baidu (BID) of China; the biotech players are Alexion (ALXN), Gilead (GILD), Celgene (CELG), Biogen (BIIB), and Amgen (AMGN).

MORE: Greece's economy is still a huge mess

At the start of 2013, the total value of those eight stocks stood at around $570 billion, accounting for 18% of the Nasdaq 100's aggregate market cap of $3.1 trillion. (The Nasdaq 100 consists of the 100 largest companies in the overall index, ranked by market cap.)

Since then, the Nasdaq has gone on a tear, rising by 39% by April 8, the day before the selloff. But the combined value of the eight high-flyers jumped by more than 80%, more than double the overall gain in the index. Alexion rose 66%, Celgene 88%, Gilead 92%, Biogen 104%, and Facebook 122%. Only Amgen -- it gained a relatively modest 40% -- failed to beat the market by a wide margin.

By April 8, the value of those eight stocks had swelled from 18% of the Nasdaq 100's total market cap to almost one-quarter, an increase of over 6 percentage points.

MORE: JP Morgan loses money every time it makes a a mortgage

And they became really, really expensive. The price-to-earnings ratios grew to 97 at Facebook and 113 at Alexion. The only company with a multiple below 28 (the number for Google) was Amgen at 17.

Over their past four quarters, the eight companies have posted combined earnings of $28 billion, vs. a combined market value of more than $1 trillion. Hence, the group, taken as a whole, is selling at 37 times profits.

If investors seek an 8% annual return from holding these volatile stocks, these companies will need a growth spurt in earnings of 15% annually for eight years, so that their profits would triple over that period. It's unlikely to happen.

The Nasdaq problem underscores a glaring weakness in cap-weighted indexes. As the prices of our eight sprinters outraced the rest of the index, a bigger and bigger share of an investor's holdings shifted to the most expensive stocks. If you kept adding money to a Nasdaq fund over that period, you were simply buying increasing portions of the overpriced stuff with every purchase.

That's the opposite of a Warren Buffett-style value strategy. Nasdaq investors are now stuck with far too much money in pricey shares that are cruisin' for a bruisin'. This crazy market is finally making a turn that makes perfect sense.

  • Why America's fear of 'too big to fail' is irrational

    The reality is U.S. companies across all industries may be 'too big to fail,' not just Wall Street banks.

    By Sanjay Sanghoee

    FORTUNE -- The U.S. Federal Reserve recently concluded that six of America's biggest banks enjoy about $8.5 billion a year in savings, mostly in the form of paying lower borrowing costs than smaller institutions. That might sound unfair, but that's a pretty small price U.S. taxpayers effectively pay to avoid another MORE

    Mar 31, 2014 2:23 PM ET
  • Corporate America's foreign cash machine: Signs it may be slowing

    As governments coordinate to fix international tax laws on overseas earnings, companies may have to pay more taxes.

    By Jack T. Ciesielski

    FORTUNE -- Costless stock options. Lending to subprime borrowers. The irrelevance of earnings and cash flow for Internet companies because they can always tap capital markets. Those are some of the good ideas gone bad on Wall Street, all seemingly foolproof at first. Costless stock options warped earnings and MORE

    Mar 31, 2014 1:14 PM ET
  • How to fix public education in America

    The U.S. spends more on education than most countries, but the private sector may have more to offer.

    By Sanjay Sanghoee

    FORTUNE -- America is at war with itself. Tension between the economic classes, highlighted by venture capitalist Tom Perkins' recent remarks, are escalating. But what we need are solutions, not words. Recriminations only polarize us further and make it harder to work collectively toward the common goal of prosperity.

    We also need MORE

    Mar 4, 2014 8:45 AM ET
  • Why Google should acquire Tesla

    It could build its own driverless electric car and stay ahead of the competition for years to come.

    By Mike Kwatinetz

    FORTUNE -- When Facebook (FB) acquired WhatsApp last week for $19 billion, it set itself apart from earlier generation technology leaders like Apple (AAPL) and Microsoft (MSFT). Facebook has decided that it wants to own the social space now, as well as in the future, and is willing to pay an MORE

    Mar 3, 2014 8:45 AM ET
  • Will the Nasdaq soar again? Not by my math.

    Why the market jolt last week was the start of a sobering reality check for tech stocks.

    FORTUNE -- Market prognosticators have conjured up many a reason for the two-day rout of stocks on Thursday and Friday, which sent the Dow Jones Industrial Average (INDU) plunging 494 points (3%) and the S&P 500 (SPX) down 55 points (3%). Some blamed the slowdown in China's perpetual manufacturing machine; others, the fears of MORE

    - Jan 27, 2014 5:00 AM ET
  • Sales pitch: What Nest said to get its original investment

    Long before being sold to Google for $3.2 billion, Nest had to persuade venture capitalists.

    FORTUNE -- Nest Labs is Silicon Valley's most recent success story, agreeing earlier this week to be acquired by Google (GOOG) for $3.2 billion. But it wasn't always such an obvious winner.

    Back in 2010, Nest's founding team went to pitch itself to venture capital firm Kleiner Perkins Caufield & Byers. The two investors with whom they MORE

    - Jan 15, 2014 3:23 PM ET
  • Tony Fadell Q&A: Why I sold Nest to Google

    Nest CEO talks Google, Apple, and why he agreed to sell.

    FORTUNE -- Nest Labs is on of the hottest companies in Silicon Valley, combining the Internet Of Things with Apple-style design and an ability to reduce carbon consumption. It was widely believed to be an IPO candidate for either 2014 or 2015, with reports that it was in talks to raise another $150 million in venture capital at MORE

    - Jan 13, 2014 5:52 PM ET
  • Google buying Nest Labs for $3.2 billion

    Google acquiring smart home appliance company.

    FORTUNE -- Google (GOOG) has agreed to acquire Nest Labs, the  trendy maker of smart home appliances like thermostats and smoke detectors, for $3.2 billion in cash.

    The deal comes just weeks after reports that Nest was raising around $150 million in new venture capital funding to be led by Yuri Milner's DST Global, which apparently never happened (and possibly was never going to).

    RELATED: Nest's newest device? MORE

    - Jan 13, 2014 4:04 PM ET
  • We need business leaders with some sense of shame

    Corporate America needs to step up and pay its fair share, instead of using shareholder value as an excuse to dodge taxes.

    FORTUNE -- At first glance, you would think that the CEOs of taxophobic U.S. corporations and our less-than-stellar leaders in Washington have nothing in common. But you'd be wrong. What they share is a lack of shame and an excess of narrow thinking.

    The similarity between C-suite tax avoiders and MORE

    - Oct 30, 2013 5:00 AM ET
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by VIP.