1-What is the metric you use for QQQE? (price ratio?)
2-metric values for cheapest to the median to expensive?
3- Any website where one can look up this metric value
That’s a little more complicated.
Here’s what I did, which piles quite a few assumptions together.
Even though it is known as a home for high growth companies, many of which will have no earnings, ultimately it’s the earnings that matter.
You pay a lot for a high growth company because you think the future earnings will be high, not because of the growth rate itself.
So, though they might trade at very high average multiples (and quite reasonably so), it’s the trajectory of earnings that is the best yardstick of the progress of value.
So, the earnings yield is the best place to start.
Since it’s 100 companies equally weighted, the median earnings yield is a good approximation of what is going on.
It is much more numerically stable than the average or sum, because it isn’t affected by wild outliers.
You don’t really care about the outliers, since no firm is more than 1% of the capital allocation.
So, I used GTR1 to construct a data series for the median earnings yield of the Nasdaq 100 set over time.
You could stop here: by comparing the current figure to the historical range you’d immediately
get a first inkling of the valuation level.
You can look at the average-through-time of the median earnings yield, or the median-through-time of the median earnings yield.
Or just average those two, which I do!
In the era since 2005, which is after the tech bubble burst, this have averaged 3.925%. (P/E of 25.5)
The current figure is 13% below that, so the first rock and roll indication is that it’s 13% overvalued compared to “normal”.
But this isn’t great, since we noticed that the earnings have dips…better to use “on trend” earnings to smooth out the squiggles.
So we keep going.
Earnings are notoriously cyclical. We can’t do a cyclical adjustment without knowing what they were.
So far we have only the earnings yields, which is the ratio of varying earnings to varying prices.
So, we need a price series for the index.
I don’t know of a source for a the historical levels of the without-dividends Nasdaq 100 Equal Weight index.
So again I used GTR1 to build one.
Just tick the “Exclude ordinary cash dividends” box.
By putting this next to the earnings yield figures, and multiplying them, you get a data set of earnings on each date.
(technically, based on median earnings, but we earlier decided that was a good proxy for the whole set).
It is arbitrarily scaled, but that doesn’t matter.
Then I did an inflation adjustment on all those earnings figures and graphed them.
The main things that jump out at you are:
- The earnings dip a lot in recessions, more than you might guess, but rapidly spring back to their prior trend line.
So, a cyclical adjustment really is necessary. - Ignoring those dips, the trend line is an astoundingly steady progression over time. Good since 1997, but especially good since around Jan 2005.
- The growth rate has been very impressive indeed.
This was all done to get a way of estimating the cyclically adjusted earnings level of the Nas 100 equal weight index, in order to get a yardstick for its value.
So, I used Excel to run a trend line through the real earnings data set.
As noted above, other than dips during recessions, the long run trend has been remarkably steady, so we’re probably not making a wild leap here.
The implied earnings yield at the moment using the “on the trend line” earnings figure suggests an earnings yield of 3.75% because earnings are a bit below trend at the moment.
This suggests the Nasdaq 100 is 5% overvalued.
The price of QQQE is $65.05, but it “ought to be” (on the dodgy reasoning above) about $62.10.
That’s on the assumptions that:
(a) The average valuation level since 2005 is a not-bad estimate of future normal levels, and
(b) That the trend of earnings growth can be extrapolated without too much danger
Both assumptions will be off, but probably no so wrong that it makes the result useless.
Since this is not an exact science, $65 counts as “trading at fair value within rounding error”.
So, now you know how I came up with my estimate of fair value.
I have a few different models using slightly different assumptions (different mounts of history, more conservative trend lines, average rather than median etc).
I just redid those models, and get figures in the range $62-72.
With the price at $65, the indication is that it’s not parricularly overvalued, nor particularly undervalued.
Why is this an investment worth considering?
- It can’t go bust.
- The rate of growth of value is astounding. With the trend line above, earnings have risen at inflation + 8.2%/year. Plus you get about 0.5% dividend yield.
- It’s a simple one-step purchase.
Downsides:
- It has been overvalued a lot of time, so it has taken patience to get it at a reasonable entry price.
It would be great to get it on sale, but that takes patience. - It contains Facebook whose management I don’t like or trust : )
- It contains about four Chinese firms listed using legally unenforceable VIE entities with no secure ownership rights.
- The selection criteria don’t give certainty that the trend of high earnings growth will continue.
They are merely the 100 biggest non-financial firms listed on the Nasdaq exchange, so they are growth firms only by tradition.
The most conservative assumption would be t hat their performance would converge to that of the average firm.
But that isn’t so bad, either, given the advantages above.
OK, as your reward for having read this far:
There is a shortcut.
As noted, at $65 it’s trading at around its fair value, give or take–around the historical usual multiple of trend earnings since 2005.
Fair value goes up over time with inflation. (I used CPI 292.3 in the analysis above).
Fair value goes up over time with trend value growth (about 8%/year)
So, you would probably be fine for a few years with this rule of thumb:
Take $65, increase it by the increase of CPI above 292.3, and then increase that figure by 8%/year since today, to get the new fair value.
Jim