Can Aussie Banks and Tech Giants Keep Up the Pace?
Written by Steve Landers & Dylan Sinclair
Recently, both Australian banking stocks and the "Magnificent 7" tech giants have attracted significant attention due to their soaring valuations. Investors often use various methods to assess a company's worth, with Price Earnings (P/E) Ratios and Earnings Multipliers being among the most common. These metrics offer different insights into a company’s potential for growth and profitability. While high valuations can indicate investor optimism, they also raise concerns about sustainability and the possibility of market corrections. This article explores the valuation trends in both sectors and examines whether these elevated prices are justified or poised for adjustment.
Methods of Assessment
Price Earnings Ratios: The P/E ratio is one of the most popular metrics. It is calculated by dividing the current market price of the stock by its earnings per share (EPS). This ratio helps investors understand how much they are paying for each dollar of earnings. A higher P/E ratio might indicate that the market expects future growth, while a lower P/E ratio could suggest the stock is undervalued or that the company is facing challenges.
Earnings Multiplier: Similar to the P/E ratio, the earnings multiplier adjusts future profits against the current interest rate to provide a more accurate picture of a company’s value. This method is often used to account for the impact of interest rates on a company’s earnings potential.
Australian Banking Stocks
Australian banking stocks have seen a significant rise in their P/E ratios. As of November 2024, the Australian banking industry is trading at a P/E ratio of 18.2x, which is notably higher than its 20yrs average of 13.5x. CBA is as high as 25.2x.
Over the past year, the Australian banking sector has gained 37%. The earnings for companies in the Australian banking sector have only grown at an average rate of 5.5% per year over the last three years.
High Price Earnings Ratios can reflect investor optimism and confidence in the long-term growth prospects of the sector. However, banks must navigate upcoming challenges such as regulatory pressures, rising costs, slowing mortgage growth and competitive dynamics to sustain growth. While there are some positive signs for the Australian Banking sector the current valuations do not appear to be justified.
The Magnificent 7
The “Magnificent 7” refers to seven of the largest tech companies: Apple, Microsoft, Amazon, Alphabet (Google), Meta (Facebook), Tesla, and Nvidia. These companies have been pivotal in driving the performance of the S&P 500. The combined P/E ratio of the Magnificent 7 stands at approximately 35x, significantly higher than the S&P 500’s P/E ratio of about 15.5x when these seven companies are excluded. While we would expect P/E ratios on the Mag7 to be a lot higher than the rest of the market due to their impressive earnings forecasts and proven historic growth, how long will it take for the earnings to catch up with the share prices? Could this be a quieter sector of the market over the next few years?
The share prices of the Magnificent 7 have soared, often outpacing their earnings growth. For instance, Apple’s earnings increased by 8.8% year-over-year, while its stock price saw a much larger increase. Similarly, Meta’s earnings grew by 35.4%, yet its stock price appreciation was even more pronounced. This disparity between share price growth and earnings growth underscores the high valuations investors are willing to pay for these tech leaders.
Both Australian banking stocks and the Magnificent 7 are trading at elevated valuations compared to their historical averages. While this reflects strong investor confidence, it also raises questions about sustainability and potential market corrections. As always, investors should consider these factors when making investment decisions and assess alternative investment options in the markets instead of blindly following momentum.