Al Root
Figuring out if a stock is overvalued is something all investors struggle with -- especially when it comes to the Magnificent Seven.
The group, which includes Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla, accounts for some 65% of the total return of the S&P 500 in 2023.
Its average year to date gain going into Friday trading was 106%, creating $5 trillion in new market capitalization. The group trades for an average of 32 times estimated 2024 calendar year earnings. It started the year out trading about 25 times.
It is, of course, difficult to say with certainty if the stocks are fairly valued, but looking at PEG ratios can help.
The PEG ratio is simply the price-to-earnings ratio divided by the earnings growth rate. Growth rates can be measured over any time frame and the PE ratio can be based on a trailing number or a based on forward estimates.
The PEG ratio for the S&P 500 is roughly two times. Earnings grow at about 9% to 10% a year and the index is trading at about 19 times estimated 2024 earnings.
To evaluate the magnificent seven, Barron's used average earnings growth expected between 2023 and 2026, based on FactSet estimates, as well as the PE ratio based on calendar year 2024 estimates.
The cheapest stock is Nvidia, with a PEG of 0.7. It is expected to grow earnings at a rate of about 34% and the stock trades for about 24 times estimated earnings.
Apple is the most expensive, with a PEG of 3.3. It is expected to grow earnings at about 8% a year on average and shares trade for about 27 times earnings.
Tesla checks in with a PEG of 2.3. It trades for about 65 times earnings and earnings are expected to grow almost 30% a year for three years.
The average PEG for the group is 1.6. If Tesla traded for the average, shares would trade for about $175 apiece, down about 30%. If Apple traded at the average, shares would be at about $87, down 55%.
High PEG ratios don't mean stocks will fall (and low ratios don't mean stocks will rise). They are only a tool. But PEG ratios can also show investors something about expectations.
Investors, for instance, are having trouble giving Nvidia full credit for its A.I.-driven earnings explosion, despite the stock's 235% year to date gain. Its PEG ratio is still below one. Apple's PEG ratio implies investors expect better-than-estimated growth.
PEG ratios also don't really work for value-oriented stocks. Take shares of Tesla automotive competitors General Motors and Ford Motor. GM is expected to grow earnings at a rate of about 3% a year on average for the coming three years. Shares trade at 4.7 times estimated 2024 earnings so the PEG ratio is 1.6.
Earnings at Ford, meanwhile, are projected to decline over the coming three years, giving its stock a PEG of minus 1.2.
That doesn't really make any sense, but PEG ratios, like any other ratio used to value stocks, are only guides.
Write to Al Root at allen.root@dowjones.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
December 16, 2023 03:00 ET (08:00 GMT)
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