If the Magnificent 7 are expensive, so is the market

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Good morning. Moody’s has cut New York Community Bancorp’s credit rating to junk, citing “high governance risks” and the potential for commercial real estate losses to create “confidence sensitivity”. The downgrade came just hours after the stock took another tumble; NYCB shares have now fallen 60 per cent in the past week. Still, though, the bank’s new credit rating, two notches below investment-grade, includes the likes of AT&T and Walgreens. It isn’t yet obvious this is a bank failure waiting to happen. Disagree? Email us: robert.armstrong@ft.com and ethan.wu@ft.com. 

The valuation of the rest of the S&P

A week or two ago, we wrote a piece implying that the Magnificent Seven tech stocks were not, as a group, in a bubble. The idea was that the S&P 500 as a whole was at about 22 times forward earnings, and the price/earnings valuations of some Mag 7 stocks were right around that level, and even the Mag 7 members trading at higher multiples did not look all that expensive, relative to their strong growth.

A reader, going by KC, wrote to ask what the valuation of the S&P 500 was once the Mag 7 were set aside. A fair question. It could be that the Mag 7 are dragging the valuation of the broad index up significantly. The answer is sort of interesting (all data from S&P Capital IQ):

• Companies in the S&P 500 have an average price/earnings ratio of 23, based on earnings estimates for the next 12 months. I have excluded four companies that are either expected to report negative earnings or for which there are no estimates (Moderna, Warner Brothers, Ventas and Loews) as negative P/E ratios mess up the maths.

• The S&P 500 as a whole has a weighted average P/E of 26, reflecting the higher valuations of larger companies in the index. Weighted average is probably a fairer representation of the value you are getting when you buy the whole lot.

• The Mag 7’s weighted average P/E is 29 (with higher average growth than the rest of the index).

• Excluding the four companies without earnings as well as the Mag 7, the S&P 489 has an average P/E of 23, essentially the same as the index as a whole.

• The S&P 489 has a weighted average P/E of 24, cheaper than the whole index, but not by much. The 489 is also not far from Apple at 28, Meta at 24 and Google at 21, and only a midsized jump away from Microsoft and Nvidia, both at 34.

All this supports the view that talking about a bubble in the Mag 7 doesn’t make loads of sense, unless you think there is a bubble in the whole market. You could argue that Amazon and (particularly) Tesla look bubbly on a P/E basis (at 41 and 59, respectively), but that is a different point.

And we are not quite done yet. It is traditional and sensible to exclude the financial sector when valuing the market, because financials generally and banks in particular cannot be sensibly valued on earnings. If we exclude the Mag 7, stocks without earnings, and financial stocks, then the market has a weighted average P/E of 25 — closer still to the Mag 7’s 29, and offering less growth.

If the Mag 7 are expensive, the market is expensive.

Boeing revisited

Last week we argued that if Boeing’s stock was going to recover from its series of production problems, the important thing was not that the company hit any particular regulatory or financial milestone. Individual “wins” of this sort will not dispel the fear that another quality issue could appear at any time. Instead, the company needs to somehow demonstrate that its entire “operational culture” (leadership, management structure, quality control processes) has been overhauled, root and branch. There have been enough problems at Boeing that we can say with confidence that the problems run deep, and a deep solution is needed.

Boeing reported earnings last week, and the stock rose 5 per cent on the results. Did management make the right noises — or do they still think its problems are anomalous and disconnected?

It was good, though more a matter of necessity than choice, that the company withdrew financial guidance for 2024, given that the investigation of the Alaska Airlines “door escape” is ongoing. It was also good that chief executive Dave Calhoun focused solely on safety issues, leaving the numbers to the CFO. And it was good, finally, that Calhoun talked about quality improvements throughout the supply chain, not only as it applies to the 737-9, the model involved in the Alaska Airlines incident. The company took a day off from production work at several big facilities to focus on quality issues.

Still, it did not strike me as enough. What I wanted to hear on the call — and on calls to come — is some discussion of what specifically went wrong with Boeing operational culture and how it is changing, with specific examples. Responding to the first official account of the incident yesterday, Calhoun said: “An event like this must not happen on an aeroplane that leaves our factory. We simply must do better for our customers and their passengers.” But a statement amounting to “we will work harder on quality now” is not reassuring, though I am sure Boeing will work harder at it; everyone in the C-suite must now know they are one incident away from being sacked. But there has to be proof that leadership knows there was something systematically wrong.

I spoke recently to an activist investor who has been involved in several efforts to transform big company culture, and he told me the following, speaking from “deep and painful experience”:

A culture-based turnaround is by far the hardest to do in the public markets, [which] force a number of constraints that dramatically slow down the process. Things that look like a crisis from the outside often aren’t enough [to force change]. Deep financial stress is often what it takes. And that is something Boeing hasn’t had. Which is why I’m sceptical much change happens.

Boeing, as I have noted before, is a blessed company: it is half of a duopoly in its core market, it has high barriers to entry and it is a strategically important company for the US. All those advantages will make change slow, by making reform less pressing. Anyone waiting for Boeing shares to recover their premium valuation had better be patient.

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