There has been much discussion in the financial press and among erudite pundits that the huge two year run up in stocks, led largely by the Magnificent Seven, has reached the point where the stock market is now unsustainably overpriced, and possibly due for a correction. These seven stocks are indeed important as they make up, depending on the day, about one-third of the total market capitalization of the S&P 500. But are they actually overvalued?
Below we will look at several traditional valuation metrics for stocks and see how current values rank relative to the last 5, 10 and 20 years as our reference. These stocks will be looked at individually and in aggregate.
Let’s start with the most traditionally used metric, the PE Ratio, which is shown in the table below. In aggregate, it’s clear that when you look relative to history, PE Ratios, aren’t horrifically high. Yes they are above the 50th percentile, but we are a lot closer to the 50th than the 90th percentile at present. The one stock that appears quite expensive across every time frame is Apple. By contrast, Nvidia’s PE valuation is not outrageous, Amazon appears cheap, and Tesla only started producing earnings and being profitable recently.
Turning to Price to Sales Ratios, the story is completely different. By this metric, the aggregate of the mag seven are very expensive. The most overvalued stock again appears to be Apple, but through the lens of sales, none of these mega-caps is cheap.
Our third metric is Enterprise Value to 12 months trailing EBITDA. We skipped the more traditional Price to Book Ratio simply because its not a great way to look at these firms, whose value is largely in intangibles. Also EV to EBITDA gives a fairly comprehensive sense of value that nicely ignores differences in capital structure. The picture it gives us is of mild, but not excessive overvaluation, when we view all 7 stocks in aggregate. Again, Apple comes off as overpriced and Amazon as actually rather cheap with most other firms in the middle.
The final measure we used was the current Price to Free Cash Flow, shown below. This provides a valuation story similar to Price to Sales, though not quite as negative. Google, Apple and Microsoft all look rather dear, while Amazon looks fairly valued to cheap. The aggregate result with percentiles in the 80s and 90s also suggests we are in expensive territory.
Finally, we aggregated all 4 of these value metrics together to see what their average percentile rank was, since percentages are comparable across metrics. Clearly, when you look out over any of the three periods of history we have used, stocks, in aggregate, are a bit pricey, since the percentile range runs from 72-83%. But we would expect to see outrageous 85-100th range figures to be really concerned. Again, Apple is clearly the expensive outlier from a valuation perspective, especially given its recent decline in growth, while Amazon looks reasonable. Even Nvidia, the recent star of the show, is not crazily priced
So are the magnificent seven (when viewed together) radically overvalued? What we see is a clear split along metrics. Metrics that don’t look at earnings like Price to Sales and Free Cash Flow suggest these stocks are very pricey. Metrics that use earnings or EBITDA suggest that we are slightly above historic fair value. When you mix all four metrics together, we can safely say that we are above normal pricing, but still quite far from the extremes.
Looking at the stocks individually, a few things stand out. Apple is overpriced no matter what measure you use, while Amazon is the best priced stock of the group. And perhaps most amazingly, Nvidia, at least on a five-year basis, is the cheapest stock of the lot.
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