Understanding the True Valuation of Roundhill Magnificent Seven ETF
Unmasking the Real Price of "Magnificent" Growth
Re-evaluating the Magnificent Seven's Earnings Multiple
Investors in the Roundhill Magnificent Seven ETF (MAGS) might be surprised to learn that the actual earnings multiple they are paying for these companies could be as high as 77 times earnings, a stark contrast to the reported 39 times. This discrepancy arises when a more comprehensive financial analysis is applied, specifically by incorporating the substantial capital investments and stock-based compensation that these firms undertake.
The Impact of Capital Expenditures on Valuation
A key factor in this re-evaluation is the escalating capital expenditure (capex) of the Magnificent Seven companies. Currently, capex accounts for approximately 14% of their total sales. This figure is notably higher than their depreciation and amortization expenses, which stand at around 6.5%. The significant difference suggests that a substantial portion of these companies' reported earnings is being reinvested in their operations, which, while potentially fueling future growth, reduces the immediate free cash flow available to shareholders. Ignoring these large capital outlays can lead to an inflated perception of profitability and, consequently, an underestimated earnings multiple.
Free Cash Flow Yield and Growth Imperatives
Given the high levels of capital expenditure, the long-term free cash flow yield for these stocks is projected to be less than 1%. This low yield implies that nearly all shareholder returns must stem from continued growth. However, the article posits that the growth trajectories of the Magnificent Seven are gradually converging with the broader S&P 500 sales growth and the overall economic expansion. This convergence raises questions about the sustainability of their premium valuations if their exceptional growth rates cannot be maintained indefinitely.
Navigating Extreme Duration Risk in Investments
Another critical concern highlighted is the extreme duration risk associated with these high-growth stocks. Even a modest 1 percentage point increase in equity risk premiums could potentially lead to a decline of over 50% in the value of MAGS. This sensitivity underscores the vulnerability of these investments to shifts in market sentiment and macroeconomic conditions, emphasizing the importance of a thorough understanding of their underlying financials beyond headline figures.
