RSP - The Magnificent Seven: Where Valuations Stand Now

2023-11-22 15:55:18 ET

Summary

• The Magnificent Seven has led the market higher throughout 2023 and are responsible for most of the gains in the S&P 500 and NASDAQ year to date.
• However, these mega-caps have seen significant increases in their valuation ratios that have outpaced their revenue and earnings growth in 2023.
• This could leave them and the overall market vulnerable to a pullback as we head into 2024.
• A "By the Numbers" look at each of the Magnificent Seven is presented in the paragraphs below.

A market economy is to economics what democracy is to government: a decent, if flawed, choice among many bad alternatives .”? Charles Wheelan.

Microsoft Corporation ( MSFT ) hit a new all-time high this week, and Nvidia Corporation ( NVDA ) reported blowout Q3 results after the bell on Tuesday. This is icing on the cake on what has been a marvelous year for the Magnificent Seven. The seven Mega caps have been in the vanguard of the rally in the overall markets throughout 2023. In fact, without these 7 names, the market's performance in 2023 would be quite lame. The small cap Russell 2000 (RTY) is up just over two percent on the year, and the equal weighted Invesco S&P 500® Equal Weight ETF ( RSP ) has risen just over three percent in 2023.

However, valuations around the Magnificent Seven are much more stretched currently than where they were when 2023 commenced. This could lead to a more tepid performance in 2024 and possibly a decent reversal in the fortunes for the Magnificent Seven in the year ahead. Let's take a quick look at each component of the Seven and their valuations after this huge rise.

Apple Inc. ( AAPL ) -

YTD Performance - Up 52.43%

P/E Ratio at Beginning of 2023 - 21.2

P/E Ratio Currently - 31.1

P/S Ratio at Beginning of 2023 - 4.9

P/S Ratio Currently - 7.7

Projected Earnings Growth for 2023 (closed) - Flat

Estimated Earnings Growth for 2024 - Five percent

Projected Revenue Growth for 2023 (closed) - Down three percent

Projected Revenue Growth for 2024 - Three to four percent.

Commentary:

Apple has seen a huge surge in its valuation as reflected in P/E and P/S ratios, despite flat/slightly negative growth in each during FY2023 which closed on September 30th. Both earnings and sales are projected to be up five percent or less in FY2024. Given the stock's P/E is north of 30 times trailing earnings, it is hard to get too excited about the equity's prospects in 2024. The shares look vulnerable to profit taking, and in a best-case scenario probably are rangebound while the stock consolidates its huge gains from 2023.

Amazon.com, Inc. ( AMZN ) -

YTD Performance - Up 67.68%

P/E Ratio at Beginning of 2023 - N/A (The company posted a loss of .27 a share in FY2022)

P/E Ratio Currently - 53.9

P/S Ratio at Beginning of 2023 -1.73

P/S Ratio Currently - 2.61

Projected Earnings Growth for 2023 - Projected to go from slight loss to $2.67 a share in profits in FY2023.

Estimated Earnings Growth for 2024 - 32.5%

Projected Revenue Growth for 2023 - 11%

Projected Revenue Growth for 2024 - 11%.

Commentary:

I love using Amazon, but it is hard to justify paying these multiples. Price to sales valuation have moved up sharply in 2023 even as sales growth is expected to remain level. I can see why Jeff Bezos has been a major seller of the shares recently.

Alphabet Inc. ( GOOG ) -

YTD Performance - Up 54.54%

P/E Ratio at Beginning of 2023 - 19.5

P/E Ratio Currently - 24.2

P/S Ratio at Beginning of 2023 - 3.9

P/S Ratio Currently - 5.6

Projected Earnings Growth for 2023 - 26%

Estimated Earnings Growth for 2024 - 15%

Projected Revenue Growth for 2023 - Eight percent

Projected Revenue Growth for 2024 - 11%.

Commentary:

While both P/E and P/S valuations have expanded noticeably in 2023, Alphabet's PEG ratio looks like a downright bargain compared with Apple or Amazon. That said, the stock could be vulnerable in 2024 if the economy enters a recession and companies cut back on marketing budgets. Stock would also be vulnerable if any of Google's rivals ever gain traction in the search area and take market share.

Meta Platforms, Inc. ( META ) -

YTD Performance - Up 170.15%

P/E Ratio at Beginning of 2023 - 14

P/E Ratio Currently - 23.5

P/S Ratio at Beginning of 2023 - 2.75

P/S Ratio Currently - 6.4

Projected Earnings Growth for 2023 - 67%

Estimated Earnings Growth for 2024 - 21%

Projected Revenue Growth for 2023 - 15%

Projected Revenue Growth for 2024 - 13%.

Commentary:

Meta Platforms has seen a huge expansion both its P/E and P/S ratio. The same commentary should apply as around Google regarding PEG ratio and vulnerability to an advertiser pull back in any recession.

Microsoft Corporation ((MSFT)) -

YTD Performance - Up 55.72%

P/E Ratio at Beginning of 2023 - 24.4

P/E Ratio Currently - 33.2

P/S Ratio at Beginning of 2023 - 8.4

P/S Ratio Currently - 11.4

Projected Earnings Growth for 2023 - 15%

Estimated Earnings Growth for 2024 - 15%

Projected Revenue Growth for 2023 - 15%

Projected Revenue Growth for 2024 - 14%

Commentary:

Both P/E and P/S have expanded by more than 30% so far in 2023. Valuation is not outlandish, but the stock still sells for north of a 2 PEG ratio. Microsoft is seeing consistent earnings and revenue growth in the mid-teens. Shares could be vulnerable if tech spending slows or the hyperbole around all things AI fades in the coming year.

Nvidia Corporation ((NVDA)) -

YTD Performance - Up 248.89%

P/E Ratio at Beginning of 2023 - 43.8

P/E Ratio Currently - 45.5

P/S Ratio at Beginning of 2023 - 18.3

P/S Ratio Currently - 22

Projected Earnings Growth for 2023 - 230%

Estimated Earnings Growth for 2024 - 70%

Projected Revenue Growth for 2023 - 110%

Projected Revenue Growth for 2024 - 50% to 55%.

Commentary:

Nvidia has been a revenue and earnings juggernaut throughout 2023 as the linchpin to the AI ecosystem. This is has led to no expansion in the stock's P/E ratio in 2023. NVDA's P/S ratio remains massive. The big question for investors is how soon will this chipmaker see significant competition in its space.

Tesla, Inc. ( TSLA ) -

YTD Performance - Up 123.13%

P/E Ratio at Beginning of 2023 - 30.3

P/E Ratio Currently - 76.9

P/S Ratio at Beginning of 2023 - 4.4

P/S Ratio Currently - 7.9

Projected Earnings Growth for 2023 - Negative 22%

Estimated Earnings Growth for 2024 - 23%

Projected Revenue Growth for 2023 - 19%

Projected Revenue Growth for 2024 - 21%.

Commentary:

Large expansion of both valuations based on P/E and P/S, especially given negative earnings growth in FY2023. Challenges in the Electric Vehicle space are mounting , and CEO Elon Musk finds himself a bigger and bigger target by critics and regulatory agencies on multiple fronts. Given this, Apple and Tesla seem to be the two most vulnerable names within the Magnificent Seven heading into the New Year.

Verdict:

Valuations have increased much faster than sales or earnings growth in 2023 throughout the Magnificent Seven. This has occurred even as rates have gone up in 2023, even in light of the recent pull back in the 10-Year Treasury yield (US10Y). This usually is a negative for growth stocks.

I can see the Magnificent Seven continue to hold their own and rallying further through year end given how heavily owned they are by hedge and mutual fund managers. However, these mega-caps are likely to face much stronger headwinds in 2024. Not only because of much higher valuations but because a recession seems likely in the coming year. "Reversion to the Mean" is likely to be a headwind for the Magnificent Seven in 2024. Or, as my late father liked to quip, nothing ever grows to the sky.

The wonder of markets is that they reconcile the choices of myriad individuals .”? William Easterly.

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