The Magnificent Seven Might Fade So the Forgotten 50 Can Shine

Chipotle’s price to earnings ratio is roughly 35. (Angus Mordant/Bloomberg)

About the authors: Arun Sai is a senior strategist and Gertjan Van Der Geer is a senior investment manager of thematic equities at Pictet Asset Management.

Investors in U.S. equities might want to end their fixation with the Magnificent Seven. Some new posses are riding into town, and they are causing a stir.

The groups of stocks in question are the Terrific 20, a cohort that is quietly mounting a challenge for the role of market leadership, and the Forgotten 50, which, as the label suggests, is a collection of well-run firms that have curiously fallen out of favor but may be soon on the rise.

The share price performance of the Terrific 20—mega cap firms operating in the consumer, financial, and energy industries, including Broadcom, Visa, and Netflix —has eclipsed that of the Mag 7 by 11% in the past year. Their continued rally is the main reason why valuations for the S&P 500 as a whole have snapped back to their cyclical high of 22 times earnings after the selloff sparked by President Donald Trump’s “Liberation Day” tariff edict in April.

This suggests the U.S. market’s rally is now on a much firmer footing, extending beyond Nvidia, Microsoft, and the five other tech behemoths that make up Mag 7.

But there is a worrying snag to the Terrific 20’s exceptional run. Their share price gains haven’t been accompanied by an improvement in their earnings prospects.

In contrast to their Magnificent peers, whose share price gains have been matched by extraordinary profit growth, the Terrific 20’s earnings have been subpar. While their stock valuations have climbed by 60% in just two years, their contribution to the S&P 500’s total profits has fallen to 15%, down from almost 20% a decade ago.

The Terrific 20 surge means even more of the S&P 500 is trading at levels that are at odds with companies’ earnings potential. According to our calculations, firms accounting for two-thirds of the index’s market capitalization now trade at a price-earnings multiple of 25 times. Less than a third of firms traded at that multiple a few years ago. In other words, there are a growing number of stocks that are attracting magnificent valuations, even when their business fundamentals aren’t improving. That leaves U.S. equities much more vulnerable should the economy stall.

Yet this doesn’t necessarily mean equity investors should retrench wholesale from U.S. markets. An equally plausible scenario is that a rotation is about to unfold, in which one group of overvalued stocks hands the S&P 500 leadership baton over to a collection of unjustifiably cheap ones. Indeed, for every Terrific 20 company that has seen its valuation soar but profit growth stall, there are at least two stocks that have experienced the exact opposite.

Enter the Forgotten 50: the cohort with the potential to become the market leaders of tomorrow. These companies currently represent just 5% of the S&P 500’s market cap, but they have seen their earnings multiples fall to just two-thirds of their long-term average over the past two years. That correction began as a response to overly optimistic growth forecasts.

But that correction now looks to have gone too far, particularly when measured against the 80% increase in these companies’ profits. The group is hardly an unknown quantity, either. It consists of hugely successful firms, such as Salesforce, Chipotle, and Eli Lilly.

There are a few practical considerations to draw from our analysis. To begin with, the stocks that have been largely responsible for the market’s stellar performance are becoming very expensive. While this might not yet fully apply to Mag 7, it certainly does to the 20 other mega caps that have quietly risen up the S&P 500 leader board in recent months.

This suggests investors should begin to diversify away from U.S. mega caps for insurance against a market correction. An alternative—or complementary—approach would be to reallocate capital to high quality companies whose shares are cheap. There are plenty of those, many of which are among the Forgotten 50.

These could be market’s new champions—once some of the mega caps begin to ride out into the sunset.

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