One Big Reason Why Tech Stocks Are Not In The 'Dot-Com Bubble'

Several large-cap tech stocks—including Amazon AMZN, Facebook FB, Microsoft MSFT, and Alphabet GOOGL—were in the green on Wednesday morning, perhaps signaling that investors are ready to pile back on these firms after the recent sector-wide selloff.

Technology companies have dominated Wall Street throughout 2017, but in a brief moment of risk aversion spurred by investors looking to sure up profits, tech stocks began to tumble from their highs last Wednesday. The tech-heavy Nasdaq Composite slipped more than 2% over the next week, and 2017 darlings like Nvidia NVDA, PayPal PYPL, and Square SQ were hammered.

Before the dip, our "Computers and Technology" sector was up over 30% on the year, outpacing the S&P 500's respectable 20% gain. This group is still well ahead of the broader market, but as we head into the New Year, investors simply seem to be less enthusiastic about tech.

The selloff appears to be relatively short-lived, but renewed volatility in the sector serves as a reminder that tech stocks are not untouchable. This is far from the first major tech rally that the market has witnessed, and it is important for investors to remember how Wall Street reacted when the sector's previous runs ended.

However, investors should be skeptical of bearish voices that are quick to proclaim today's tech market the second-coming of the infamous dot-com era bubble.

The "dot-com bubble" refers to a historic period of over-valuation in the tech sector caused by the widespread adaption of the internet in the late-90s. Shares of internet-based companies skyrocketed, and investors were willing to pour cash into anything that ended in "dot-com."

By the turn of the century, however, overspending and a lack of real sales and profitability pulled the rug out from underneath the sector. Some of the period's most-hyped companies, including Pets.com and Webvan, went completely out of business, while giants like Qualcomm QCOM and Cisco CSCO watched their market capitalizations plummet.

But herein lies the difference between the dot-com bubble and today's tech growth. Earnings and revenue growth were never able to keep up with dot-com era valuations, while contemporary valuations are actually supported reasonably well by earnings and revenue.

For reference, check out the average Forward P/E of our "Computers and Technology" sector during the dot-com bubble versus today:

At the turn of the century, we were looking at tech P/E ratios in the 50s, nearly doubling the average of the broader S&P 500. Sure, today's tech valuations are a bit loftier than the market as a whole, but the difference is miniscule by comparison.

Prolonged tech rallies make investors uncomfortable because, to many, the dot-com bubble was not that long ago. However, the fundamental picture right now is significantly different. Smart investors cannot ignore these differences.

Want more stock market analysis from this author? Make sure to follow @Ryan_McQueeney on Twitter!

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