Tech stocks are in a massive bubble, if you listen to many of the talking heads on Wall Street. And it’s easy to see how they came to this conclusion. Just look at the trillion-dollar valuations of Microsoft and Apple alone.
Welt’s Holger Zschaeapitz accurately pointed out that the combined market capitalization of Apple (APPL) and Microsoft (MSFT) alone is now larger than the entire German stock market.
“The market value of all listed German companies, at $2.18tn, is smaller than that of the 2 largest US corporations. Apple and Microsoft have a combined market capitalization of $2.233tn.”
At first glance, this seems like sure evidence of a bubble. Germany is no small fish; it’s the largest economy in Europe. How can two companies be worth more than the entire German stock market?
Of course, the story here is much more complicated than a simple chart…
Rob Arnott, partner and CEO at Research Affiliates certainly lives in the “bubble” camp. Last month he said ‘FANMAG’ – an acronym referring to Facebook, Amazon, Netflix, Microsoft, Apple and Google – was wildly overvalued.
“Will these stocks produce such impressive growth that they will justify their current market cap, or are these implausible growth expectations? We do not have a crystal ball, of course, but we would recommend not betting on the momentum continuing.”
Reminder: analysts also called FAANG stocks a bubble in 2015 and 2016. Meanwhile Apple and Microsoft shares have almost tripled since 2015.
But let’s take Apple and Microsoft since they’re the specific stocks mentioned here. Their trillion-dollar valuations are lofty, but not without good reason.
Apple stock isn’t overvalued at all, based on the standard price/earnings ratio. As the Motley Fool wrote:
“Apple is still only valued at a price-to-earnings (P/E) ratio of 19. That’s nowhere near the 70-plus P/E ratio that Amazon trades at or the multiple of 30 that Facebook is currently trading around.”
There’s an argument to be made that some tech stocks, like Netflix, are overvalued, but Apple doesn’t seem to fall into that camp. Don’t forget that Apple has $94 billion cash in the vault, too.
What about Microsoft? MSFT stock is marginally overvalued compared to the historical stock market average (using price/earnings ratio). But it’s undervalued, based on MSFT’s historical average. Microsoft arguably enjoys a more generous P/E allowance by investors because it’s still growing rapidly. Company earnings continue to outperform, while its cloud computing arm, Azure, is growing revenue by 64% annually.
Based on these metrics, it’s hard to justify claims that Apple and Microsoft are overvalued.
Comparing Apple and Microsoft to the entire German stock market is a flawed comparison. Despite being the largest economy in Europe, Germany’s stock market is not an accurate representation of its output. As Deutsche Bank research put it:
“The German stock market has always been relatively small.”
Why? A variety of reasons from lack of investing culture and poor tax treatment to the large number of privately held companies.
“German retail investors tend to be cautious and risk-averse, which is reflected in their comparatively low equity holdings and the catchphrase “missing equity culture.”
Not only that but German pension funds barely touch the stock market while tax rules discourage risk-on investing. A further factor is that many German companies are family-owned.
“Numerous mid-sized German companies are (exclusively) family-owned, whereas they are often listed on the stock market elsewhere, particularly in Anglo-Saxon countries.”
The comparison to Apple and Microsoft makes for a compelling chart, but the reality means it’s not as scary as it sounds.
Last modified: September 23, 2020 1:15 PM