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May 2, 2015

A Social Media Crash After NASDAQ Sets a New High

It was ironic to see Twitter (TWTR) incur a large price drop so soon after the NASDAQ set its first record high since the dot-com bubble. Shares of the social media company fell by more than 18% on Tuesday and fell further on Wednesday following a leaked earnings announcement, disappointing first-quarter revenues and lowered guidance. It was a sequence of events that supported Mark Twain’s supposed observation of history rhyming.
After the NASDAQ peaked in March 2000 with a then-record closing high of 5,048.62, all publicly traded Internet companies saw their share prices plunge. A common trait of the dot-com companies of that era were business models based on converting website traffic into eventual profits. Willing investors paid a hefty premium based on the hope of future profits justifying even higher share prices.
Fast forward to 2015 and the story for Twitter is close to being a mirror image. The fourth page of its annual 10-K filing with the Securities and Exchange Commission (SEC) discusses metrics the company wants investors to focus on; they include “active users” and “timeline views.” This is corporate speak for “don’t worry about profits, we’ll make up for it in volume.” Say what you want about Twitter’s usefulness as a communication medium, the fact remains that from an investment perspective, Twitter is just a modern version of the dot-com companies from late 1990s: plenty of users, a questionable business model and only the hope of one day generating enough profits to justify the current high valuation.
Should the NASDAQ’s recent record high prove to be a short-term top—and I’m not predicting that it will—there will likely be some who point to Twitter, and other social media stocks, as examples of valuations running too high. Such a comparison would be wrong.
The NASDAQ Composite is a different index than it was at the height of the tech bubble. A recent report from Ned Davis Research summarized the differences nicely. Tech companies comprised 67.3% of the index in March 2000; as of last week, their weighting was 46.1%. Health care and consumer discretionary companies combined to account for 14.4% of the index in March 2000; they now each have a 17.5% weighting (or 35% combined).
Valuations for the many of the large technology companies are also much lower now than where they were in March 2000. Apple (AAPL), Microsoft (MSFT), Intel (INTC) and Cisco Systems (CSCO)—all of which currently rank among the NASDAQ 100’s largest stocks—currently trade at less than 20 times earnings. As you know, technology stocks traded at sky-high valuations back in March 2000. (The NASDAQ 100 is comprised of the 100 largest stocks within the NASDAQ Composite index.)
Seasonality could play a role in how the NASDAQ performs over the next several months. The so-called “worst six months” starts tomorrow, May 1. Stocks have historically, on average, experienced smaller gains during the six-month period between May and October than between November and April. The Dow Jones industrial average declined by an average of -1.1% and rose by an average of 9.3% over the two periods since 1950, respectively, according to the Stock Trader’s Almanac. Other indexes have similar periodic comparisons. The NASDAQ's weakest period is a bit shorter, running between July and October. The Stock Trader's Almanac calculates an average gain of 0.4% versus 11.4% for the other eight months since 1971. Thus, any weakness in the NASDAQ may be caused by the typical ebb and flow of stock prices as much as anything else.
It’s also important to be aware of a stock's influence on an index. Twitter exemplifies the group of social media companies that continue to command high valuations on the hope of the future profits. Twitter, however, is not a NASDAQ 100 company and its debacle this week has no impact on the NASDAQ Composite. Rather, the NADSAQ's direction will be determined by companies other than Twitter.
Thus, while the timing of this week’s drop in Twitter was ironic, it is not as damaging to the NASDAQ as the downfall of dot-com stocks following the bursting of the tech bubble in 2000 was.
The Week Ahead

Earnings season continues, with more than 80 members of the S&P 500 scheduled to report their quarterly results. The only Dow Jones industrial average component in the group is The Walt Disney Co. (DIS) on Tuesday.
The first economic report of note will be released on Monday: March factory orders. Tuesday will feature the ISM’s April non-manufacturing index and March international trade data. The April ADP Employment Report and the first estimate of first-quarter productivity will be released on Wednesday. Friday will feature April jobs data, including the change in the nonfarm payrolls and the unemployment report, as well as March wholesale trade.
Several Federal Reserve officials will make public appearances, as is typical following a Federal Reserve Open Market Committee (FOMC) meeting. San Francisco president John Williams will speak on Monday; Chicago president Charles Evans and Minneapolis president Narayana Kocherlakota will speak on Tuesday; and Chair Janet Yellen, Kansas City president Esther George and Atlanta president Dennis Lockhart will speak on Wednesday.

About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle
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