The diverging fortunes of tech giants and growth companies that have boosted the U.S. stock market have put a spotlight on their lofty valuations.
The so-called “Magnificent Seven” are trading at an average of 33 times forward earnings over the next 12 months, up from 26 times at the end of 2022, according to LSEG Datastream.
By comparison, the benchmark S&P 500 index has a price-to-earnings ratio of about 21 times, and has risen more than 7% this year.
Investors were willing to spend money on mega-cap acquisitions last year given the company’s strong balance sheet and dominant position at the top of the industry.
They’ve become even more discriminatory this year, fueling Nvidia’s dizzying profits while punishing Tesla and Apple stocks, which have seen uncertain prospects.
“When you reach a valuation like this, there is no room for failure or disappointment,” said Mike Malaney, director of global market research at Boston Partners.
Concerns about demand for electric vehicles have caused shares of Tesla, once a market darling, to fall nearly 35% this year, making it the worst-performing company in the S&P 500.
The stock’s forward P/E ratio was about 65 times at the beginning of the year, but has now fallen to about 50 times.
Apple, another member of the Magnificent Seven, has ceded its title to Microsoft as the largest U.S. company by market capitalization after its stock price has fallen 10% since the beginning of the year under pressure from its China operations. The company’s P/E ratio fell from 29 times to 25 times.
Meanwhile, chipmaker Nvidia, which trades at a price-to-earnings ratio of about 35 times, has soared about 80% as it has established a dominant position in artificial intelligence applications.
AI optimism also contributed to the nearly 40% increase in meta platforms. Facebook’s parent company has a P/E ratio of 24x.
In contrast, last year’s Magnificent Seven was around 50% for Apple and over 230% for Nvidia. The group’s performance accounted for more than 60% of the index’s gain last year, as it is heavily weighted in the S&P 500 index.
The S&P 500 rose 24% in 2023.
The market awaits next week’s Federal Reserve meeting, which closes on Wednesday.
A strong economy and persistent inflation have lowered investors’ expectations about how much the central bank will cut interest rates this year, leading to higher Treasury yields and potentially weighing on stock prices.
Investors looking to see if Nvidia can leverage its large lead in AI computing to long-term advantage will be keeping an eye on the company’s developer conference, scheduled to begin on Monday.
AI optimism has helped lift some of the Magnificent Seven, but many investors are struggling with how to value the technology’s potential in their valuation models.
“We’re in a unique cycle here in AI, so we’re making sure we’re optimizing for the opportunity for massive transitional change in this technology,” said Ken Loudan, portfolio manager at Buffalo Large Cap Fund. We are having a hard time adapting to this,” he said. Add them together and you get an underweight.
Strong earnings have supported Magnificent Seven’s valuation, but the group’s growth trajectory is expected to moderate late this year or early next year, said Jeffrey Bachbinder, chief equity strategist at LPL Financial. Ta.
“At that point, the market may not want to pay a P/E of 2x for this group,” Buchbinder said, adding that the Magnificent Seven’s P/E ratio is 41x compared to the S&P 500’s P/E of 23x. He pointed out that it was twice as much.
Many investors remain optimistic about the Magnificent Seven’s valuation.
JPMorgan strategists said this week that the group is trading at a discount to the market than it was a few years ago, with five of the seven companies trading below the median P/E ratio over the past five years.
In fact, NVIDIA’s P/E ratio is down from nearly 60 times a year ago, as analysts have raised their earnings estimates for the chipmaker.
“These companies are generating huge amounts of cash, very strong balance sheets and tangible sources of earnings growth,” said Katie Nixon, chief investment officer at Northern Trust Wealth Management. Ta.
However, Apple and Tesla stock prices have recently fallen below their 200-day moving averages. Citigroup analysts said that while the rest of the group’s companies are outperforming that benchmark, many of the Magnificent Seven’s falls below the trend line could be a “warning sign” for the market.
Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, said that if the Magnificent Seven “starts to fall, that could reverse much of the almost euphoric sentiment of late. There’s no doubt about it.”
