Fracturing ‘Magnificent Seven’ trade puts spotlight on megacaps

Diverging fortunes for the massive technology and growth names that have propelled the US stock market higher are throwing a spotlight on their pricey valuations.

The so-called “Magnificent Seven” are collectively trading at an average of 33 times their expected earnings for the next 12 months, up from 26 at the end of 2022, according to LSEG Datastream. That compares with a price-to-earnings ratio of about 21 for the benchmark S&P 500 index, which has risen over 7 per cent this year.

Investors last year were happy to pay up for the megacaps, given the companies' solid balance sheets and dominant positions atop their industries. They have been more discriminating this year, punishing the shares of Tesla and Apple when their outlooks turned murky while fueling dizzying gains in Nvidia.

“When you get to those kinds of valuations you have no room for failure, no room for disappointment,” said Mike Mullaney, director of global markets research at Boston Partners.

Concerns about electric vehicle demand have sparked a near 35 per cent drop in the shares of the former market darling Tesla this year, making it the S&P 500's worst performer. The stock traded at about 65 times forward earnings at the start of the year, and is down to about 50.

Another Magnificent Seven member, Apple, has ceded its perch as the biggest US company by market value to Microsoft after its shares declined 10 per cent year-to-date, amid pressure in its China business. The stock's P/E has fallen from 29 to 25.

Meanwhile, chipmaker Nvidia, which trades at about 35 times earnings, has soared about 80 per cent as it established a dominant position in artificial intelligence applications. AI optimism has also helped drive a nearly 40 per cent gain in Meta Platforms. The Facebook parent trades at 24 times earnings.

By contrast, the Magnificent Seven last year advanced about 50 per cent for Apple to over 230 per cent for Nvidia. Because of the stocks' heavy weighting in the S&P 500, the group's performance accounted for over 60 per cent of the index's appreciation last year. The S&P 500 rose 24 per cent in 2023.

If the Magnificent Seven “start to go down ... you could reverse a lot of the recent almost euphoric sentiment,” said Sameer Samana, senior market strategist at the Wells Fargo Investment Institute.