Tech Stocks Look Overvalued, but Not Absurdly So

Stocks haven’t looked this overpriced in 20 years, one Wall Street economist wrote this past week. He cites the 10-year Treasury yield, recently up to about 5%, compared with the “earnings yield” of the S&P 500 index, or the price/earnings ratio flipped upside down, which is also near 5%.

Let’s focus on another point the bulls make about the S&P 500’s valuation. It has been driven higher by recent gains for seven tech giants that carry the most sway in the index—or that did until this past week, when Tesla had an earnings oopsie-daisy, and fell behind Berkshire Hathaway . More on that in a moment.

Step 1: Predict precise free cash flows far into the future, say 10 years, even though Wall Street routinely guesses wrong on much easier measures like revenue for the current quarter. Here’s an alternative that’s less mathy and more appropriately iffy. It doesn’t have a high-finance-sounding name. I’m considering “disgruntled crash-flop electrolysis,” but I have to check the trademark status. DCFE involves starting with things we already know, like today’s price, or can safely assume, like that an investor buying shares of one of these Big Tech companies would want to be decently rewarded—say, with 12% yearly returns over the next five years.

Microsoft, Alphabet, and Amazon are three more companies with a path to joining the $100 billion free-cash-flow club at some point within the next several years, giving the U.S. the financial equivalent of four Aramcos. Amazon has much further to climb than the others, and all carry regulatory risk, but the idea is the same: Puttering around with the numbers, today’s prices don’t look ludicrous in light of the plausible path for free cash flow. Ditto for Meta, but on a smaller scale.

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