Big Tech Stocks Are Still Expensive. Why That’s Important For the Market.

This post was originally published on this site

Nvidia stock trades at an average forward earnings multiple of about 38 times.

Justin Sullivan/Getty Images

Big Tech stocks are still expensive, despite all the market’s down times this year. And that’s key for the S&P 500.

Now, the giants— Apple (ticker: AAPL) and Alphabet (GOOGL) are two examples—haven’t walked away untouched. They’ve gotten caught in the selloff just like the rest of the S&P 500, which is down about16% from its early January all-time high.

The market just hasn’t been able to shake off two big worries—the Russia-Ukraine war and a recession triggered by the Federal Reserve, desperate to bring down inflation with higher interest rates.

Still, comparatively speaking, Big Tech is expensive. Those names are simply more richly valued than the tried-and-trues of other industries— Ford (F), for example, or Pfizer (PFE).

The key metric is the earnings multiple. Apple and Alphabet—along with Microsoft (MSFT), Amazon.com (AMZN), Meta Platforms (META), Tesla (TSLA), and Nvidia (NVDA)—trade at an average forward earnings multiple of about 38 times. And that’s just below the sub-17 times aggregate multiple for the S&P 500. 

Big Tech has been able to pull a rabbit out the hat because of its bright future: relatively fast profit growth.

Amazon’s dominance in e-commerce, for example, lets it keep taking market share from bricks-and-mortar retailers—and even other online sellers. Tesla remains the leader in electric vehicles, which are displacing gas-fueled vehicles. Nvidia is entering a brand-new metaverse business, which adds new opportunities.

Analysts expect these three—the fastest-growing of the seven Big Tech names—to see earnings per share compound by at least 20% annually for the next three years, according to FactSet.

The upshot: The multiples of these stocks will stay high. And that’s key for the S&P 500 because high multiples for Big Tech keeps the index’s aggregate multiple—and consequently its price level—elevated.

The index is market cap-weighted, which means companies with higher market capitalizations have more influence on the index’s level. The combined market cap for the seven tech names is roughly $8.8 trillion—just over a quarter of the index’s total market value.

What investors should realize—or remember—is that if Big Tech multiples sink fast so will the stock prices—and the lower prices would drag down the S&P 500. 

Now, Big Tech multiples will come down rapidly if the growth expectations of their businesses slow down quickly.

Netflix (NFLX) knows. The streaming platform has essentially dropped out of the Big Tech group, with a mere $100 billion market cap. The growth of entertainment steaming is slowing and Netflix’s forward earnings multiple fell just below 17 times for a moment this year, down over 20 times.

Meta Platforms knows, too. The tech giant revealed slowing advertising growth on its last earnings report. Today, the stock trades at about 15 times earnings, down from—again—over 20 times.

“It takes a monumental blowup like Meta/Facebook …to crack valuations,” wrote Jessica Rabe, co-founder of DataTrek. 

The soundest advice is to focus on the long haul. As a company’s growth slows, its multiple should decline gradually—not all at once. That’s already happening: Microsoft’s current 24.7 times multiple is down from a pandemic-era peak of 34 times. 

An orderly decline in Big Tech multiples could allow the rest of the market to gain over the years as companies across the board, including Big Tech, still grow their earnings streams. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com