Stocks at 40 Times Profits Are Cheap, Wall Street Has Determined

Buying shares trading at 40 times earnings may not sound like a good deal. But that’s exactly what Maneesh Deshpande is telling clients to do.

The head of equity derivatives strategy at Barclays Plc just upgraded his recommendation on Apple Inc. and other technology giants, advising investors to own more of these stocks. Often known as Faamg, the group is getting a reprieve after lagging behind the market since October.

As stretched as the Faamgs look -- a 35% premium over the S&P 500 Index -- Deshpande says judging valuations based on an absolute level or comparing them to the rest of the market is flawed because it doesn’t acknowledge the growth advantage that these tech giants offer in the long run. In other words, they deserve a higher multiple because of their superior earnings power.

A more appropriate approach, Deshpande says, is to measure the shares against their own history. Going by that, the valuation of Faamg stocks is now on par with levels seen before the pandemic. By contrast, the S&P 500 fetches a premium relative to where it was in December 2019.

“It’s like saying New York real estate is cheap right now, but it’s not going to be as cheap as Montana ever. It’s cheaper relative to where it was,” Deshpande said by phone. “That is still notable.”

The tech behemoths, once superstars at the top of the leaderboard, had a tough start to the year. Their total market value rose less than 8% in the first five months, while indexes tracking commodity and financial shares each advanced more than 20%. The underperformance came during increased Washington discussions about regulations and taxes and as the threat of higher interest rates weighed on richly valued stocks.

Now with inflation expectations starting to abate, the Faamg stocks -- Facebook Inc., Apple, Inc., Microsoft Corp. and Google parent Alphabet Inc. -- are reclaiming dominance. The group has climbed 6.3% this month, a gain that none of the 11 main S&P 500 industries has been able to beat. Without them, the index’s 0.9% gain would have reversed to a loss of 0.4%.