Are the “Magnificent 7” really that magnificent?
Just seven stocks—Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla—account for almost 30% of the S&P 500 market cap. Those seven companies have contributed more than half of the S&P 500’s 32% rally since the start of 2023. The magnitude of gains in some of the single stocks over that time period has been astounding: Nvidia share prices have more than quadrupled, Amazon’s have doubled, and Microsoft’s and Alphabet’s are up more than 70% and 60%, respectively.
We think the gains have been justified. The latest earnings reports from the cohort, save for Nvidia (theirs will come in late February), show three key dynamics that have pushed the names to new highs:
Earnings growth is picking up steam and looks likely to stay strong.
Valuations remain reasonable, despite the recent rally.
The potential of artificial intelligence is accelerating, and the Magnificent 7 are both enablers and beneficiaries of it.
That said, not all of the companies included under the Magnificent 7 moniker have shined equally. Tesla, for example, is becoming something of the runt of the group, having fallen out of the top ten list of the world’s largest companies. Voices on the Street have even started to question if Tesla belongs in the Magnificent 7. As such, our piece today will focus on the other six companies in the group.
Earnings growth is picking up steam
The earnings story for the Magnificent 7 starts with cost control measures put into place after 2020’s pandemic-era tech binge turned into a hangover in 2022 and part of 2023. Amid a slowdown in demand across business functions, the “hyperscalers” (Microsoft, Amazon and Google) tightened their belts on costs and reduced headcount to protect profit margins.
Then ChatGPT burst onto the scene. Not only did the platform bring artificial intelligence into the limelight, it also increased real demand for artificial intelligence implementation and related services. We expected that the AI craze would ultimately create a reacceleration in cloud growth—something that came to fruition this earnings season. Microsoft’s Azure, Amazon’s Web Services, and Google’s Cloud Products all beat growth expectations in the fourth quarter, and management teams struck an upbeat tone on forward guidance.
The combination of leaner cost structures and reaccelerating demand has offered a boost to earnings estimates for the year ahead.
The Magnificent 7 is expected to continue to outpace the earnings growth of the broader market
This chart shows YoY earnings-per-share growth for the Mag-7, remaining 493, S&P 500 and S&P 400 for 2024 and 2025.
Source: FactSet. Data as of February 8, 2024.
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Valuations still look reasonable, even in light of the recent rally
After rallying more than 100% in aggregate in 2023, the Magnificent 7 stocks have shown no sign of slowing this year. Valuations have expanded modestly, but a larger proportion of the increase can be attributed to rising expectations for earnings in the year ahead.
At face value, there is no denying that the megacap stocks trade at a premium to the rest of the S&P 500. But when comparing the aggregate forward price-to-earnings ratio to history, it is roughly in line with the 10-year trailing average. Given our confidence in the earnings trajectories, we prefer to look at valuations on an earnings growth-adjusted basis. This measure, called the price-to-earnings-to-growth ratio, shows that the Magnificent 7 valuations still look reasonable to inexpensive.
Megacap valuations look more reasonable when adjusting for future growth expectations
This chart shows 2024 price-to-earnings/2024 earnings growth (PEG) ratio for the Mag-7, remaining 493, S&P 500 and S&P 400 for 2024 and 2025.
Source: FactSet. Data as of February 6, 2024
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AI potential is accelerating
The pace of innovation in the technology sector is leading to massive investment; the enablers and beneficiaries could stand to profit.
AI adoption is the most tangible example today, and it’s already producing results in real time. Take Microsoft: AI most recently contributed double the amount of growth to its cloud business than in the previous quarter.
To support the ongoing growth, Microsoft, Meta, Alphabet and Amazon are expected to funnel massive amounts of capital expenditure to data centers. That investment is expected to bring additional sources of income for the likes of Nvidia (which will round out the Magnificent 7 earnings later this month) and other chipmakers (e.g., Advanced Micro Devices just increased its outlook for its data center CPU from $2bn to $3.5bn). Not only that, but the accelerated pace of adoption of these technologies means that the impact is reaching beyond the tech and tech-enabled sectors.
The bottom line: We think they’re called “magnificent” for a reason
The AI hype is real: Companies are producing earnings results to validate the rallies they have seen over the past year. And with the largest names in the technology space accounting for a large share of both U.S. and global equity benchmarks, the story matters for all equity investors.
But as these megacap names and the broad equity market continue to grind higher, we think today’s environment makes the case for a focus on “alpha” over “beta” through a more selective approach. More than a third of S&P 500 stocks are still down since the start of 2023, and we see the potential for other themes—such as healthcare innovation and ongoing consumer resilience—to support recoveries in some areas going forward. With a dispersion of earnings results both within and between sectors, careful stock selection can help tap outperformance opportunities. The current environment looks like fertile ground for active equity managers.
Your J.P. Morgan team is here to help ensure that your portfolio is closely aligned with your financial goals and long-term plan for the years ahead.