Figuring out if a stock is overvalued is a challenge that investors often face, especially when it comes to the renowned group known as the Magnificent Seven. This influential group consists of Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla. Remarkably, they accounted for a remarkable 65% of the total return of the S&P 500 in 2023.
As of Friday trading, the average year-to-date gain for these companies sat at an impressive 106%, which resulted in a staggering $5 trillion increase in market capitalization. While their trading multiples for estimated 2024 calendar year earnings average around 32 times, it’s worth noting that they began the year at around 25 times.
Naturally, determining whether these stocks are fairly valued is no easy task. However, one valuable metric to consider is the PEG ratio.
The PEG ratio represents the price-to-earnings ratio divided by the earnings growth rate. Growth rates can be assessed over any time frame, and the PE ratio can be based on either trailing numbers or forward estimates.
For the S&P 500, the PEG ratio is approximately two times. Earnings generally grow at a consistent rate of about 9% to 10% each year, leading to the index trading at around 19 times estimated 2024 earnings.
To assess the Magnificent Seven, we relied on average earnings growth anticipated between 2023 and 2026 using FactSet estimates, as well as the PE ratio based on calendar year 2024 projections.
Among these stocks, Nvidia emerges as the most attractively priced option, with a PEG ratio of 0.7. Furthermore, it is projected to achieve an outstanding earnings growth rate of approximately 34%, while trading at around 24 times estimated earnings.
On the other hand, Apple stands out as the most expensive stock, with a PEG ratio of 3.3. Although it is still expected to achieve healthy annual earnings growth of about 8% on average, its shares trade at approximately 27 times earnings.
By considering these key details, investors can better navigate the valuation of these prominent stocks within the Magnificent Seven.
Tesla’s PEG Ratio and Growth Expectations
Tesla, a prominent player in the automotive industry, currently boasts a PEG ratio of 2.3. This indicates that it trades at around 65 times its earnings, with an estimated annual growth of nearly 30% over the next three years.
When compared to the average PEG ratio of the industry group, which stands at 1.6, Tesla’s valuation appears higher. If Tesla were to trade at the industry average, the stock would be priced at approximately $175 per share, representing a significant decline of around 30%. Similarly, if Apple traded at the average PEG ratio, its shares would experience a substantial drop of 55%, bringing the price to around $87.
However, it is important to note that high PEG ratios do not necessarily indicate an impending decline in stock prices, just as low ratios do not guarantee a rise. PEG ratios serve as a tool for investors, offering insights into market expectations.
One such example is Nvidia, which has seen a remarkable 235% increase in stock value year-to-date due to its AI-driven earnings growth. Surprisingly, despite this impressive performance, Nvidia’s PEG ratio remains below one. On the other hand, Apple’s PEG ratio suggests that investors anticipate better-than-expected growth.
PEG ratios may not be suitable for evaluating value-oriented stocks. This becomes evident when analyzing Tesla’s competitors in the automotive industry: General Motors (GM) and Ford Motor. GM is projected to experience an average annual earnings growth rate of approximately 3% over the next three years. With shares trading at 4.7 times estimated 2024 earnings, its PEG ratio stands at 1.6.
In contrast, Ford’s earnings are expected to decline over the next three years, resulting in a negative PEG ratio of minus 1.2. While this may seem illogical, it highlights the fact that PEG ratios, like other valuation metrics, should only be used as guides.