Companies run by "Bubble prophet" Grantham: "Seven Sages" not a bubble; median P/E ratio is only 27 times

The strong rebound in the US stock market in 2024 has led some on Wall Street to believe that the tech sector may be in a bubble similar to the dot-com bubble of the 1990s. However, the legendary value investors, known as “bubble prophets”, at GMO, the investment management company run by Jeremy Grantham, argue that the comparison between today’s “Big Seven” and the boom-and-bust cycle of the late 1990s is not justified, as there are fewer reasons for concern about the fundamentals and multiples of these mega-tech companies.

In 2000, the median price-to-earnings multiple of the top 10 US companies was 60 times, as investors were “bewildered” by the then-communications revolution and the companies’ 22 per cent annual returns over the previous five years.

GMO calculates the companies’ fundamental returns by calculating the income from dividends and earnings per share growth. The team estimates fundamental returns by estimating expected returns from dividend yields and consensus earnings growth.

In an optimistic scenario, if the top 10 companies had achieved a median fundamental return of 19 per cent every year since 2000 and stock prices had remained unchanged over the next five years, the median price-to-earnings multiple would have been more than 25 times by 2005.

However, the “opposite” has been the case, with the median fundamental return of the group only 8 per cent a year, “relatively meagre”. The investment team said: “The total return has been terrible, perhaps not surprisingly, with the best performer in the group — the only one to deliver a positive return — being Exxon Mobil.”

Today, the top 10 US companies have delivered an impressive median fundamental return of 19 per cent a year since 2019, but the median price-to-earnings multiple is only 27 times, compared with 60 times in 2000.

The GMO investment team said that if the top 10 companies were to achieve a 19 per cent fundamental return expectation and stock prices remained unchanged over the next five years, the price-to-earnings multiple would fall to 12 times by 2029. “Investors are expecting less from the current mega companies than they did in 2000. In a way, the risk is lower.”

The GMO investment team said: “While the market looks similar on the surface, no one can predict the near term. But from a long-term perspective, whether the current mega companies will be great investments or not-so-great investments will depend on their fundamental evolution and the impact on valuation multiples.”

Thursday’s fall in the US stock market was driven by concerns about a slowdown in the economy, as the number of Americans applying for unemployment benefits jumped to 24.9mn, near the one-year high, and a key factory index fell for a fourth consecutive month to an eight-month low.