After long stocks rally, is the bear in sight?

In his 2001 letter to shareholders, Warren Buffett quipped, "After all, you only find out who is swimming naked when the tide goes out." A prudent observation in times of market exuberance.

During the late 1990s, investors were willing to ignore traditional valuation metrics as they drove Internet stock prices ever higher. The price-to-earnings multiples (P/E) expanded to stratospheric levels in companies with no sustainable earnings power. But the tide was in and investors were jumping in with both feet.

We are entering year seven of strong equity performance, and it seems sensible to check the tide. The arguments on both sides of the question are compelling. It is hard to deny that valuations have increased significantly from market lows in 2008; the indices are reaching new highs. At these potential turning points, those with the microphone tend to repeat the latest conventional wisdom over and over. We need to dig a little deeper.

By knowing the facts we can navigate conflicting opinions. If you are a consumer of financial news you have no doubt heard lots of discussion around when the Nasdaq will cross the 5000 level and whether that will that signal a market top. The Nasdaq, comprised largely of technology and biotech stocks, first hit the 5,000 mark in 2000 and then began a decline that continued long after the S&P 500 and Dow Jones Industrial Average bottomed.

Barron's Alexander Eule examined the question in his recent article "To Nasdaq 5,000 and Beyond." Since peaking, the Nasdaq has taken 12 years to recover the 3,900 points lost, which represented an 80 percent decline in market value. Twelve years!

Eule wisely compares the valuations of the top Nasdaq holdings then and now. To do so he examines the company's (and the index's) P/E. In 2000, the Nasdaq sported a P/E multiple of over 100 times earnings. Today the index carries a much more reasonable P/E ratio of 21 — a modest premium to the slower-growing S&P 500, which is trading at 17.5 times earnings.

Only one stock in the top 10 of today's Nasdaq carries an Internet bubble-like P/E: Amazon.com (AMZN). AMZN trades at a whopping 717 multiple of earnings. Even newcomer Facebook (FB) is trading at a somewhat reasonable multiple of 39. Compare that to Nasdaq stocks in 2000 and you will find Cisco's (CSCO) P/E multiple then at 127, currently trading at 13.6; Intel at 43 times earnings, now trading at 14; Oracle (ORCL) at 103 times, now carrying a multiple of 14.8.

Apple (AAPL), the largest company in the world and the largest company in today's Nasdaq top 10, trades at a P/E multiple of just 14.7 times estimated twelve-month earnings.

We are far from Internet bubble levels. Yes, Nasdaq 5,000 is an important event of which to take note, but once we dig into the numbers, we get a glimpse of who is really swimming naked and who isn't.

Nancy Tengler spent two decades as a professional investor. She is an author, financial-news commentator and university professor. Reach her at nancy.tengler@cox.net.