Markets and Fundamentals: The Evidence  109
top-30 company had a P/E of 46 times, compared with an average of 23 times 
for the other 470 companies. As a result, the weighted average P/E for the 
market overall reached 30 times.
Most of the large-capitalization companies with high P/Es were clustered 
in just three sectors: technology, media, and telecommunications (TMT). Of 
course, some of the companies born in this era (including Amazon and eBay) 
have created substantial economic value. But for every solid, innovative new 
business idea, there were dozens of companies that forgot or purposely threw 
out fundamental rules of economics.
By 2007, stock markets around the world had more than recovered from 
the technology bubble fallout, and the S&P 500 reached a new peak value (see 
Exhibit 7.8). The largest property boom and credit expansion in U.S. and Eu-
ropean history drove corporate earnings to exceptional levels that ultimately 
proved unsustainable. Although all companies were affected, this bubble too 
was mainly driven by a few sectors. The financial, energy, utilities, and ma-
terials sectors showed sharply inflated earnings, from 41 percent of total S&P 
earnings in 1997 to 51 percent in 2006. But in 2007, a chain reaction of col-
lapsing funding structures for mortgages and other forms of credit brought 
financial institutions across the world into distress. U.S. and European stock 
markets lost more than half of their value as the world’s economy experienced 
the steepest downturn since the 1930s.
After 2009, U.S. stock markets quickly regained momentum and reached 
new record levels, this time fueled by strong increases in returns on capital 
and revenue growth, especially in the life science and technology sectors (see 
also Chapter 8). The megacap phenomenon emerged again, although on a far 
more modest scale than in the high-tech bubble. As of 2018, just four mega-
cap companies—Alphabet (Google), Amazon, Facebook, and Microsoft—
accounted for 10 percent of the S&P 500 index.12 European stock markets took 
much longer to regain pre-crisis levels, due to weaker underlying return on 
capital and growth. The 2010 sovereign debt crisis caused a prolonged slow-
down of economic activity across the largest European countries. In addition, 
European countries did not experience the emergence and ongoing growth of 
a strong technology sector, as the United States did.
Paradoxically, the fact that market deviations do occur from time to time 
makes it even more important for corporate managers and investors to un-
derstand the true, intrinsic value of their companies; otherwise, they will be 
unsure how to exploit any market deviations, if and when they occur. For 
instance, they might use shares to pay for acquisitions when those shares are 
overvalued by the market, or they might divest particular businesses at times 
when trading and transaction multiples in those sectors are higher than un-
derlying fundamentals can justify.
12 See Gupta et al., “Looking behind the Numbers for US Stock Indexes.”