Broker Check

Are They Really That Magnificent?

March 01, 2024

The “Magnificent 7” stocks have been all over the news for good reason. In 2023, Apple, Nvidia, Microsoft, Tesla, Amazon, Alphabet (Google), and Meta (Facebook) outperformed the other 493 stocks in the S&P 500 by 62% (76% vs 14%)1.

The chart below shows that these seven highflyers now trade at a multiple of future earnings (light blue line) almost twice as high as the rest of the index (dark blue line).

Pundits have jumped all over this story, with some calling it the next big bubble. These seven stocks currently represent more than 30% of the S&P 500, so their fate is of material importance to most investors. So, let’s see if there is cause for concern.

The price-to-earnings ratio (P/E ratio) is a standard valuation metric for stocks because investors often value earnings. The intuition is analogous to real estate. How much someone is willing to pay for $1 of company earnings is similar to what a home buyer is willing to pay for a single square foot of a house.

But valuation measures are useless on their own. Vanguard even published a report that concluded the P/E ratio and other valuation metrics have been unable to predict the future of stock prices since 19262. Therefore, any pundit who claims that the Magnificent 7 will crash solely due to a high P/E ratio should be ignored for the same reason a bull should be for recommending a stock solely because of a low P/E ratio.

The chart below depicts how different these seven stocks are from most other constituents in the S&P 500. The second bar from the left is their combined profit, and it’s higher than all other countries’ combined listed companies except China and Japan. It’s apples and oranges.

Not only have they generated staggering earnings, but investors expect their future growth to significantly outperform the rest of the S&P 500. The first chart below shows they are projected to grow sales 4x faster, and the second shows they are estimated to do so while expanding margins by more than 2% by 2026.

Add it all up, and these are massive enterprises that generate more profit than entire stock exchanges of most countries with growth expectations that defy mathematical principles like the law of large numbers.

Furthermore, shift the timeline, and the narrative follows. The chart below shows that while the Magnificent 7 had a stellar 2023 and start to 2024, the story is much less sanguine when incorporating the savagery of 2022. Collectively, they are still outperforming, but only modestly, and after falling significantly more than the rest of the index in 2022 (dark blue line).

The bottom line

So, what’s the verdict? The Magnificent 7 may be big and profitable, but are they the next tech bubble?

It’s hard to look at companies this lucrative and conclude that their combined valuation is egregiously high. But they also don’t look like a screaming deal, either. This is all subjective, but I’d wager they are fairly valued, with some constituents more attractive than others.

However, this subjectivity is also highly dependent on the investment strategy. Day traders value stocks differently than long-term holders because both own stocks for different reasons. We fall in the latter, so we tend to value long-term profits and cash flow far more than exploiting near-term anomalies in P/E multiples.

What is far less subjective is the notion of any bubble. These do happen, but they require way more than a few stocks rising after a brutal selloff. Bubbles are a result of a complete disassociation of fundamentals and price, fueled by a mania devoid of all logic and reasoning.

The bottom line is that the Magnificent 7 is not another tech bubble. At least not yet.


 

 

Sources

1 Goldman Sachs.

2 https://personal.vanguard.com/pdf/s338.pdf

 

Disclosures

This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.