The Big 5: Into The Twilight Zone

The Big 5: Into The Twilight Zone

This week the big cap tech stocks continued to defy the doubters. Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and Facebook (NASDAQ:FB) all reported Thursday and beat the Street estimates for revenue and earnings. And the market reaction said that there is no price too high to pay for the growth in these companies’ businesses. Our reaction is first that the analyst estimate/company reported earnings “game” is the one of the biggest smoke-and-mirror con jobs in financial markets. A company beating estimates (either guided down by the company itself or by analysts who lower the bar to encourage institutional sale of shares) does not really bring “new information” that should justify a sudden +10% pop in already fully-valued stock prices (as seen in Apple Friday). With that said, yes, these tech giants are taking over the world and it is amazing. Our second distrust comes from the simple fact that even the greatest company should not be priceless. The greatest athlete in the world (pick your sport) has never signed a contract for $1 trillion. These is a limit to how much one should pay for “greatness”. Our point, there is a maximum price to pay for ANYTHING. The current run-up in the Big 5 tech stocks (Apple, Amazon, Microsoft (NASDAQ:MSFT), Google, and Facebook) is not likely setting a new paradigm for how to value an asset. Like most skeptics, we are watching in amazement as more and more money crowds into the same five tech stocks, while the value trade slumps even further.

As of Friday, the approximate weight of the Big 5 in the S&P 500 (considered best measure of the “U.S. stock market”) is up to 23%. We have discussed in our past commentaries that in a possible tech bubble, where so few stocks drive the S&P 500, that this headline index is not the best measure of equity market strength. In fact, we benchmark our stock selection portfolio to the Invesco S&P 500 Equal Weight ETF (RSP), so as not to be driven into crowded, overvalued stocks in order to minimize underperformance near-term relative to the S&P 500.

Bigger Than The Cumberland Gap

We updated our S&P 495 charts versus the Big 5 after Thursday night’s blowout Tech earnings. However you slice it, the gap between the Big 5 and the rest of the market has reached enormous proportions. The first chart looks back about 18 months, with a starting point on December 31, 2018. Over this period, the S&P 500 less the Big 5, or the “S&P 495”, is up +7.9%, COVID crisis included. Meanwhile, the Big 5 stocks have essentially doubled in value. The COVID crisis turned out to be a springboard to propel the tech stocks to stratospheric levels.



The next chart compares the S&P 500 that everyone loves to the S&P 495 over the same period. Besides the obvious fact that the S&P 500 would still be in the doldrums without the Big 5’s contribution, what this chart reveals is that “the market” is still in a downtrend since the pre-COVID peak. The blue line, representing the S&P 495, is still in a configuration of forming lower highs, as indicated by the trendline.

The final chart zooms in on just 2020, to capture the relative COVID impact on the S&P 495 versus the Big 5. This is the most jaw-dropping chart: the market is down -11.4% while the Big 5 are up over 50% year-to-date. It is said that markets can remain irrational longer than an investor can remain solvent. While it will take deep pockets to bet against the Big 5 in the second half of 2020, this gap is absolutely not sustainable. Even if we are talking about the greatest five companies in history.

Traditional Valuation Metrics

So much for the stock price deviations. As for valuation by traditional metrics, the gap is also getting absurd. Of course, an enthusiastic tech investor will quickly dismiss valuations saying that in this world dearth of growth, investors need to pay up for growth stocks. This may be true, for now, but over a long enough time horizon, overpriced stocks tend to revert back to the mean.

Below we compiled a summary table showing the multiple expansion for each of the Big 5. In this first table, we use the optimistic forward P/E’s, which use analysts’ rosy future earnings estimates.

Forward P/E on July 30, 2020

Forward P/E recorded on June 30, 2019

Multiple Expansion

Apple

25.13

15.97

9.16

Microsoft

31.25

26.11

5.14

Amazon

138.89

58.82

80.07

Google

35.71

23.42

12.29

Facebook

31.75

25.19

6.56

Big 5 Mean

52.54

29.90

22.64

S&P 500 Equal-Weight

19.6

18.3

1.3

Amazon’s forward P/E at 139x is a bizarrerie in financial markets, and the mean P/E of the remaining four drops to “only” 31.96x. But that is still a far cry from the market at 19.6x. In total, forward P/E estimates of the Big 5 have increase almost 23 times while the broad market P/E has expanded just over 1x.

The next table shows price/earnings ratios using realized, trailing earnings. The multiple expansion message is the same, confirming the enormous jump in the valuation gap between the Big 5 and the market over the past year.

TTM P/E on July 30, 2020

TTM P/E on June 30, 2019

Multiple Expansion

Apple

29.72

16.58

13.14

Microsoft

35.43

29.77

5.66

Amazon

143.35

79.03

64.32

Google

30.45

27.16

3.29

Facebook

32.17

28.68

3.49

Big 5 Mean

54.22

36.24

17.98

S&P 500 Equal-Weight

22.62

20.80

1.82

Conclusion

We enjoy watching, holding a bag of popcorn, the craze of investors shoving each other aside to crowd into the Big 5 stocks before the next guy. This film will end badly, but as spectators, it will be entertaining to watch. If readers are inclined to our point-of-view, the safest way to trade this upcoming train wreak is to buy the S&P 500 Equal-Weight, a proxy for our S&P 495, and to short a basket of the Big 5 stocks (or more simply, short the Nasdaq-100 QQQ). Good news on a COVID vaccine and/or good news on the economic recovery will disproportionately favor the lagging cycle stocks. In the meantime, the extent of the valuation gap between the market and the Big 5 today should at least slow the above price divergence.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


Originally published on Seeking Alpha

S&P 500 
$3,294.61  0.72%  
NASDAQ 100 
$11,055.08  1.37%  
Dow Jones Industrial Average 
$26,664.40  0.89%  
Apple Inc. 
$435.75  2.52%  
Alphabet Inc. 
$1,474.45  -0.57%  
MICROSOFT CORP 
181,82 €  6.71%  
Tesla, Inc. 
$1,485.00  3.79%  
Berkshire Hathaway Inc. 
$298,800.00  1.76%  
AbbVie Inc. 
$95.94  1.09%  
Costco Wholesale Corporation 
$329.32  1.16%  
Smartsheet Inc. 
$48.40  1.38%  
Zai Lab Limited 
$80.25  5.44%  
Western Digital Corporation 
$43.90  1.86%  
NVIDIA Corporation 
$440.41  3.73%  
Gold Aug 20 
$1,992.40  0.31%  
Crude Oil Sep 20 
$40.75  -0.63%  
BTC/USD 
$11,336.96  0.81%  
Bitcoin Cash USD 
$299.03  0.50%  
LTC/USD 
$59.04  0.97%  
ETH/USD 
$398.36  3.12%  
Dogecoin USD 
$0.0034  0.65%