Whenever the largest stocks have a growth spurt, we hear worries about their dominance in the S & P 500 , fears about how disproportional their impact has become, and predictions of their imminent decline. That means it’s wise to examine the true power these names have over their smaller colleagues in the index. For the first data cut in this analysis, I focused on the big four: Apple , Microsoft , Alphabet and Amazon . We combined both of Alphabet’s share classes for this exercise. These four are responsible for 46% of the 17% gain in the S & P 500 year to date. Generally, Nvidia , Meta and Tesla are in the megacap circle. However, META and TSLA are not in the exclusive trillion-dollar club. NVDA is a recent arrival but trades at such a price to sales premium to the others – at least 30 times for this calendar year – that it might distort the original analysis. Adding up the market value of the top four yields a total dollar amount of $8 trillion and a weight exceeding 20% of the S & P 500. Let’s think about what that means. Dollar units for the charts below are in the millions of dollars. Holding sway in the broad-market index The enormous effect on the S & P 500 from moves in these stocks becomes clear when we observe the weighting of each quintile within the names comprising the index. As shown below, the bottom three hundred names in the index comprise only a 15.5% weight. So, what does that mean when it comes to offsetting the effect of a selloff in the big guys and gals? If the group collectively falls 5%, the resulting drop in value is roughly $480 billion. For the S & P 500 to remain flat, what needs to happen? The entire bottom quintile of the S & P would need to rise by 44% to cover that nearly $500 billion loss in value. Fifty stocks (10% of the S & P) worth $20 billion – around the size of Ulta Beauty – would need to climb around 50% to cover the shortfall. Some 100 stocks the size of Delta Air Lines (roughly $27 billion) would need to rise 20%. Twenty-five stocks the size of Micron Technology (about $72 billion) would need to jump 25%. Historical context for valuations Naturally, just because these stocks have tremendous influence over the market doesn’t mean they deserve that clout. The charts below provide insight into some historical comparisons of valuation. As mentioned earlier, the nearly 21% value weight for this group of four, comprising under 1% of names in the index, seems eye-popping, but lopsided wealth distributions are common in recent years. Indeed, 1% of the world’s richest people own about half its wealth, according to a 2017 Credit Suisse report . The combined weight at the top has greatly expanded over the past twenty years. In 2003, the largest stocks – General Electric , Microsoft, Pfizer and Exxon Mobil – represented merely 4.4% of the total index market value. By 2013, the share commanded by giants Apple, Exxon, Microsoft and GE rose to 8.9% of the S & P 500. One principal factor in their market strength is the size and range of the markets they built: software, communications, online shopping and search. In 2003, the top four’s share of S & P net profit was 4%, but today’s leaders churn out 14.8% of the net gains. That’s still below their 21% market value share, but it helps explain what investors are paying for: exceptional free cash flow and sustainable margins. The net profit margin of the 2003 leaders was 8.7% compared to 10% today, so it’s reasonably close. However, these huge tech-heavy firms both created new industries and dominated them in a manner that has proven unassailable. This allows them to grow without intense competition, a fact not lost on U.S. and European Union regulators. For example, Pfizer was the third largest stock in 2003 and had sales of $45 billion compared to Microsoft’s (No. 2 that year) $34 billion. In 2022, MSFT’s sales were $198 billion, up 482%, compared to PFE’s $100 billion and its profit, 2.3 times that of the drug company. Price/earnings ratio of this year’s giants The price/earnings ratio is another measure of valuation. The above table shows that the top four today have an average PE of about 33 times last 12 months’ earnings, which seems very high but is not very far from 31 times in 2003 and only 20% higher than 27 times in 2013. Even closer is the PE ratio of this group to that of the index overall: 1.4 times today, compared to the same ratio in 2003. When we add Nvidia and Meta to the mix, the power group of six accounts for 25% of the S & P value and more than 16% of its net earnings. However, on a PE basis, the group average of about 36 is 1.5 times the S & P’s, in line with the prior decades. Where does this lead us? The S & P 500 will struggle without participation from its biggest components. Whether these names can retain their enormous weight in the index relies on their ongoing profitability. In turn, that depends on their ability to withstand competition from the free market or regulatory changes. Karen Firestone is chairperson, CEO and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.
