NASDAQ and the R&D-Tech Revolution

Source: Thinkstock

It’s been a bumpy start for stocks so far in 2014, but the fact of the matter is that the NASDAQ Composite Index is up this year and hit a 14-year high in the latest trading session (highest level since 2000.) The same cannot be said for the Dow Jones Industrial and S&P 500 indices, which are both lagging and down for the year. Not only did the NASDAQ outperform the Dow by almost +12 percent in 2013, but the NASDAQ has also trounced the Dow by over +70 percent over the last five years.

Is this outperformance a fluke or random coincidence? I’d beg to differ, and we will explore the reasons behind the NASDAQ being treated like the Rodney Dangerfield of indices. Or in other words, why the NASDAQ gets “no respect!” (See also: NASDAQ Ugly Step Child.)

Compared to the “bubble” days of the nineties, today’s discussions more rationally revolve around profits, cash flows, and valuations. Many of us old crusty veterans remember all the crazy talk of the “New Economy,” “clicks,” and “eyeballs” that took place in the mid-to-late 1990s. Those metrics and hyperbole are used less today, but if NASDAQ’s dominance extends significantly, I’m sure some new and old descriptive euphemisms will float to the conversational surface.

The technology bubble may have burst in 2000 — scarring memories of the -78 percent collapse in the NASDAQ (5,100 to 1,100) from 2000-2002 — but has not been forgotten. Despite that carnage, technology has relentlessly advanced through Moore’s Lawwhile internet connectivity has proliferated in concert with globalization. FedEx’s (NYSE:FDX) Chief Information Officer Rob Carter summed it up nicely when he noted that,“The sound we heard wasn’t the [tech] bubble bursting; it was the big bang.”

Even with the large advance in the NASDAQ index in recent years, valuations of the tech-heavy index remain within reasonable ranges. Accurate gauges of the NASDAQ Composite price-earnings ratio (P/E) are scarce, but just a few months ago, strategist Ned Davis pegged the index P/E at 21, well below the peak of 49 at the end of 1999. For now, the scars and painful memories of the 2000 crash have limited the amount of frothiness, although pockets of it certainly still exist (greed will never be fully eradicated.)

Why NASDAQ & Technology Continue to Flourish

Regardless of how one analyzes the stock market, ultimately, long-term stock prices follow the direction of profits and cash flows. Profits and cash flows don’t however grow out of thin air. Sustainable growth requires competitiveness. For most industries, a long-term competitive advantage requires a culture of innovation and technology adoption. As you can see from the NASDAQ listed companies below, there is no shortage of innovation.

(Click to enlarge.)

Sources: ADVFN, SEC, Other

Sources: ADVFN, SEC, Other

I’ve divided the largest technology companies in the NASDAQ 100 index that survived the bursting of the 2000 technology bubble into “The Old Tech Guard.” This group of eight stocks represents a total market value of about $1.5 trillion — equivalent to almost 10 percent of our country’s Gross Domestic Product (GDP.) Incredibly, this select collection of companies achieved an average sales growth rate of +19 percent; income growth of +22 percent; and research & development growth of +18 percent over a 14-year period (1999-2013.)

The second group of younger stocks (a.k.a. The New Tech Guard) that launched their IPOs post-2000 have accomplished equally impressive results. Together, these handful of companies have earned a market value of over $625 billion. There’s a reason investors are gobbling up these stocks. Over the last five years, the New Tech Guard companies have averaged an unbelievable +77 percent sales growth rate, coupled with a remarkable +43 percent expansion in average annual R&D expenditures.

Is Innovation Dead?

Who said innovation is dead? Not me. Combined, these 13 companies (Old Guard + New Guard) are spending about $55,000,000,000 on research and development — annually. If you consider the hundreds and thousands of other technology companies that are also investing aggressively for the future, it should come as no surprise that the pace of innovation is only accelerating.

While newscasters, bloggers, and newspapers will continue to myopically focus on the Dow and S&P 500 indices, do your investment portfolio a favor by not forgetting about the relentless R&D and tech revolution taking place within the innovative and often overlooked NASDAQ index.