Chart of the day: Techs vs industrials

By Felix Salmon
July 22, 2011
Larry Summers for suggesting that I take a look at this chart.

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Thanks to Larry Summers for suggesting that I take a look at this chart. It wasn’t particularly easy to find, but it’s quite striking all the same. (And thanks very much to Roy Strom and Van Tsui, here at Thomson Reuters for putting it together.)

What we’re looking at here is a ratio of ratios: it’s the price/earnings ratio of the companies in the MSCI USA IT index, which covers technology companies, divided by the price/earnings ratio of the companies in the MSCI USA Industrials index. (For earnings, we’re using 12-month forward earnings — but we’re not really looking at the p/e ratios themselves here, just the ratio between the two ratios.)

Summers is absolutely right: this ratio is currently at an all-time low. The TR data goes back to 1994, so this chart encompasses 17 years, but I suspect you’d need to go back a lot further to find the last time this ratio was trading this low.

Importantly, the ratio is trading at less than 1: the market is saying that earnings at technology companies, which historically exhibit high growth, are worth less than earnings at established industrial companies.

Now this might be an artifact of the specific indices I’m using here: according to another chart sent to me by John Coogan, the ratio is still at an all-time low, but is above 1. Still, the fact is that the market clearly isn’t giving technology earnings the premium they’ve historically commanded.

Why might that be? Frankly I don’t really know. Maybe it’s a function of industrial earnings rebounding less quickly than earnings in the tech sector more generally. Maybe it’s largely an Apple thing. But there’s definitely an indication here that either industrial earnings are too expensive, or technology earnings are too cheap right now. Or both.


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I don’t think it is an artifact of the indices… Compare the valuations of MMM and UTX vs. HPQ, CSCO, MSFT, and IBM. For the “mature” companies like that, it is at least a 50% gap.

That said, the tech giants are facing some tough sledding in growing revenues. I think people have come to anticipate downward revisions of the earnings projections.

Tech has also historically been a huge money-waster. They have “reinvested” cash as rapidly as it comes in, typically for mediocre returns, while diluting their core business through employee stock options. If they can find good ways to return earnings to shareholders, they’ll attract more interest from value investors.

Posted by TFF | Report as abusive

Was there any tech before 1994? :)

Seriously, I believe the point Summers was making was either that innovation itself is at an all-time low (and reflected in the market with a lower premium), or that we as a society valued innovation less than we used to (you will be amazed at the people who are ignorant of the practical innovations that have come out of our now more-or-less defunct space program).

However, you may also be able to argue that we value industrialization more highly right now, perhaps because of its historical ability to create large numbers of middle-class jobs. It would be useful to know the values of the baseline ratios over time.

A couple of caveats. First, circa 2000 is clearly the result of a NASDAQ that was out of whack. Second, as you’ve noted in recent posts, more tech companies are trying to stay private longer, which could skew our perceptions of whether or not significant innovation is occurring. We don’t really hear about a lot of them until the pre-IPO hype.

Posted by Curmudgeon | Report as abusive

“But there’s definitely an indication here that either industrial earnings are too expensive, or technology earnings are too cheap right now. Or both.”

Why would you think that? It could well be that the US has become less competitive compared to the rest of the world in tech, compared to its competitiveness in industry. This might reflect, for example, the fact that much of the rest of the world has pulled way ahead of the US in education.

Posted by JasonDick | Report as abusive

as they say – if you torture the data enough, it’ll confess to anything

Posted by ReformedBroker | Report as abusive

This may be sheer foolishness, but doesn’t this say less about tech than it does about the industrial sector. Industrials have done well over the last decade, but a major military power has been involved in two wars. People may be willing to pay for that sort of demand side certainty.

Posted by http | Report as abusive

JasonDick, the big companies (and the bulk of the market cap) are all multinationals. If anything, the industrials are more tightly tied to the US than the tech companies.

Posted by TFF | Report as abusive

I think it may have to do with the fact that technology companies are now viewed as being a lot riskier than they used to be because of the pace at which technology is evolving. Today’s highflier may be obsolete by tomorrow morning…just look at AOL, MySpace, etc.

Posted by mfw13 | Report as abusive

BTW, the correct title is “my good friend Larry Summers.” He would like that.

Posted by maynardGkeynes | Report as abusive

Felix, post-96 history isn’t necessarily indicative considering the bubble years’ very high pe ratios for techs. Students of graham/buffett also know, given how volatile tech business is, that tech might command a lower pe ratios than industrials. And yhis isn’t only a graham/warren claim. This is what Bill Gates said back in 1998 (while MSFT was trading at over x30): “I think the multiples of technology stocks should be quite a bit lower than the multiples of stocks like Coke and Gillette, because we are subject to complete changes in the rules. I know very well that in the next ten years, if Microsoft is still a leader, we will have had to weather at least three crises.”

Posted by buysidemetrics | Report as abusive

Isn’t this exactly what one would expect to see in a deflationary or near deflationary environment?

Posted by fredmertz | Report as abusive

I think that there is a megacap low P/E bias here. Having techs as megacap stocks is a relatively new phenomenon, but Apple, Amazon, Broadcom, HP, Dell, EBay, Microsoft, Google, Cisco, Verizon, AT&T, Oracle and Yahoo are up there in the Russell top 200 stocks. Once a company is a megacap, it becomes very hard to grow since you typically already dominate market share, your products are entering a mature growth phase, and even if you can find millions in new revenues, it is a drop in the bucket. Since the charted P/E average is probably market weighted, these mature companies dominate the tech calculation.

Posted by TurtleBay | Report as abusive

I believe the gap can at least be partly explained by the fact that execs in the tech sector spend so much time going to hipster conferences (SXSW!) and otherwise acting like cliquey high-school kids, while their counterparts in the industrial sector are at the office making sure their companies are actually selling stuff at a profit. And no, I’m not kidding.

Posted by ErikD | Report as abusive