The magnificent seven stocks -- Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia, and Tesla -- have been stellar performers on Wall Street over the last 12 months, up 107% compared to 26% of the S&P 500.
These unusual gains for such a short time in such an adverse interest rate environment have raised some skepticism on Wall Street as to whether the group can keep on rallying for much longer.
"It's no secret that the Mag seven was the primary driver of returns in equity markets in 2023," Adam Coons, Certified Financial Analyst (CFA) and Portfolio Manager at Winthrop Capital, told International Business Times. "The dominance of these seven stocks naturally begins the narrative of "they cannot possibly keep going up, can they? Just because something has performed much better than expected does not mean that it must experience a mean reversion."
Still, Marc Dizard, Chief Investment Strategist, PNC Asset Management Group at PNC Financial Group, sees valuations for the group are getting stretched, at least on the surface. "From a traditional valuation sense, the Magnificent Seven names appear overvalued," he told IBT. "As a group, they trade at a weighted average of 32.4x in the next twelve months' P/E, which is well above the already elevated S&P 500 in the next twelve months' P/E of 20.5x."
Even with this, he believes these valuations are balanced as this is a high earnings growth group of companies. "Looking at blended growth rates for 2023, the S&P 500 is looking at muted earnings growth of +1%, and if you take out the Magnificent Seven names, it drops to nearly -7%," he explained. "So yes, valuations are higher for the Magnificent 7 – but warranted for the group delivering earnings growth significantly better than the remaining 493 names."
Robert R. Johnson, Ph.D., CFA, CAIA, Professor of Finance, Heider College of Business, Creighton University, thinks the big run-up in the magnificent seven stocks has nothing to do with valuations. Instead, it's due to index fund buying, as the group represents 29% of the S&P 500 by market cap.
"Of course, they occupy the top spots in the S&P 500 weighted by market cap as they have performed very well over the past year," he explained. "But one of the reasons they have performed well is that when investors buy index funds that track the S&P 500, they need to buy more shares of these stocks. In other words, demand for these stocks rises as more investors buy index funds, increasing the price. In a bull market, demand for these stocks rises irrespective of traditional valuation concerns due to indexing."
Dizard doesn't want to concentrate on the magnificent seven, but he doesn't want to neglect them in a portfolio. "These are names I want exposure to—without them, the return profile for an investor looks much different," he said. "However, I want to be valuation aware."
Coons is looking into other areas of the market to find stocks with more upside potential and a lower level of overall downside risk over the next few years. "Time and time again, investors have to be reminded that valuations matter and cannot be ignored long term," he stated. "This time around will likely be no different."
"My bottom line is that while I wouldn't bet on the Mag 7 stocks going forward, I wouldn't bet against them either," added Johnson. "Those brave investors looking to bet against the Mag 7 by shorting them may find that a reckless strategy. As John Maynard Keynes once said, 'The market can stay irrational longer than you can stay solvent.'"
Editor's Note: The writer owns shares of Magnificent Seven stock, except Tesla.
