The Magnificent Seven

From Challenger Chief Economist Dr Jonathan Kearns

The Magnificent Seven

The Magnificent Seven (Mag7) stocks have come to dominate the S&P 500. The market capitalisation of these seven stocks – Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla – has increased by a factor of almost ten over the past decade and is now almost US$15 trillion (averaging 25% increase per year over the decade). The Mag7 stocks now account for almost one-third of the market capitalisation of the main equity index in the United States, the S&P500.

Six of these seven stocks have a market cap over US$1 trillion, with three around the US$3 trillion mark. The increase in market cap has been impressive for all of these companies, especially Nvidia which some five years ago had a market cap of just US$80 billion, a minnow compared to today’s US$2.8 trillion following the surge in its price over the past week after yet another positive earnings report.

This impressive growth raises many questions, most notably: are the Mag7 overvalued and what is their effect on the valuation of the overall market? The Price-Earnings (PE) ratios, a common measure of valuation, of these seven stocks are high, and have increased in recent years. Champions of these stocks point to their strong earnings growth potential and their entrenched market position. Detractors are dubious that such valuations can last in the long run, but history is littered with doubters whose short positions have gone bust waiting for the long run.

The sheer size of the Mag7 and their high valuations mean they have a sizeable impact on the overall market. The combined PE ratio of the Mag7 is a touch under 30, which has pulled up the PE ratio for the S&P500 to almost 22, comfortably above its long-term average of around 18. But the PE ratio of the S&P500 excluding the Mag7 is less than 20, closer to its historical average. All this goes to show that whether you think the US equity market is overvalued mostly depends on whether you think the valuations of the Mag7 are justified by their growth potential. They’ve delivered in spades over the past decade, but can they keep doing that over the coming decade?