The 3 Best Stocks In A Frighteningly High Nasdaq

If baseball great Yogi Berra looked at a 20-year chart of the Nasdaq Composite Index, he might say that it’s “Déjà vu all over again.”

To those who lived through the tech bubble, yours truly included, the chart does look eerily foreboding. And always remember that the most dangerous, and expensive, phrase in the English language is “this time it’s different”.

At the turn of the century, top internet service provider American Online (AOL), now owned by telecom giant Verizon (NYSE: VZ), had just announced a now ill-fated merger with content trove Time Warner (NYSE: TWX). Recently, online retailer Amazon (Nasdaq: AMZN) announced it was acquiring grocery chain Whole Foods Market (NYSE: WFM) in its attempt to conquer the world, I guess.

But while history may be starting to rhyme as the Nasdaq reaches nosebleed territory, and there is room to argue that the index does need to blow off a little froth, things may not be as treacherous as they may appear. Here are three observations.

1. Inflated Valuations Are Concentrated
While the Nasdaq may be hitting all-time highs, the charge is being led by five stocks: Apple (Nasdaq: AAPL), Alphabet (Nasdaq: GOOG), Microsoft (Nasdaq: MSFT), Amazon, and Facebook (Nasdaq: FB). These five companies represent 42% of the more focused Nasdaq 100. During the tech bubble, the valuation mayhem was much more widespread.

2. The Economy Isn’t As Hot As It Was
In 1999, U.S. real GDP growth was a scorching 4.8%. In 2000, it cooled off a bit to 4.1%. Compare that to 2016’s 1.6%. 2017 is shaping up to be a real barnburner, with first quarter GDP growth coming in on two wheels at 1.4%. Maybe the markets know something that we don’t?

3. The “Next BIG Thing” Hasn’t Arrived
The Internet as a “thing” was what drove the Nasdaq to excess in the last decade of the twentieth century. From the internet “backbone” (aka telecom networks) to the ill-fated, the tech investing landscape resembled an Oklahoma land rush. Currently, the “next BIG thing” hasn’t quite arrived. A decade ago, the cloud was the rage and, granted, did evolve to a high degree of importance. However, the two biggest players in the 90s turned out to be the two biggest players in the cloud space: Amazon and Microsoft. From robots to driverless cars, there’s a lot of talk, but no overarching tech trend has emerged.

#-ad_banner-#Another anecdotal observation is that the individual investor mania that defined the Tech Bubble just isn’t there. Your neighbor at the barbeque isn’t bragging about the outsized returns he’s made in the red-hot, no-load tech fund in his 401(k). 

Despite the record run up on the Nasdaq, or the “Nasty” as a colleague of mine used to call it, there are some decent bargains in a few high-quality tech names.

Cisco Systems (Nasdaq: CSCO), the gold standard in networking and connectivity, will benefit for many years to come as the “internet of things” theme continues to play out, which it will. Shares are modestly priced just under $32 with a forward P/E of 13.4, which is a 36% discount to the Nasdaq’s 20.9 forward P/E. The stock also throws off an attractive 3.6% dividend yield.

While desktops and laptops seem like ancient history, never, I repeat never underestimate the importance of Intel (Nasdaq: INTC), the world’s largest manufacturer of microprocessors. The company’s girth and leverage have enabled it to expand its reach beyond what was once considered traditional computing into mobile devices, automobiles, appliances and other things that require processing. The stock trades at nearly a 10% discount to its 52-week high at $34 with a forward P/E of just 12.1 and a 3.1% dividend yield.

Lastly, one of my favorite business development companies (BDCs), Hercules Capital (Nasdaq: HTGC) provides mezzanine-level capital to smaller, high-tech, high-growth companies that usually require both a debt and equity structure. Shares trade around $13 with a cheap forward P/E of 10.7 and a fat dividend yield of about 9.3%.

Risks To Consider: Just as a rising tide can lift all boats (although not really in this case), falling markets tend to take no prisoners. If the Nasdaq is poised for a pullback, things could be brutal across the board. At the end of the day, market behavior is still dictated by human behavior which is always predictably unpredictable. 

Action To Take: The past may or may not be prologue as far as the Nasdaq is concerned. While the toppy charts may seem familiar, underlying circumstances are not.

As a basket, these three stocks trade at a 42% discount on a forward P/E basis to the Nasdaq. I’ll hold back on making a return projection due to the elevated nature of the Nasdaq. However, that’s an extremely attractive discount for three high quality names that pay a blended yield of 5.36%. An income stream that solid is a good defensive measure in the event of volatility.

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