The Magnificent Seven have been top performing tech stocks. Investing in them seems like a no-brainer. This was true in the past, but may not be true in future.

The Magnificent Seven

The Magnificent Seven includes:

• Apple

• Microsoft

• Google

• Amazon

• Nvidia

• Meta

• Tesla

The 5-year performance of these companies has been stellar. Combined, these companies make up more than 25% of the S&P500 index and more than 50% of the Nasdaq 100 index.

The common theme with these companies is their ability to collect customer data, create hardware and software, and to use the power of artificial intelligence.

As you can see from the table below, five of the seven are part of the trillion dollar club (i.e. companies worth a trillion dollars or more).

Looking in the rear view mirror

These companies are great and the trends sound like they are intact. But are these great investments?

Investing is forward looking. It’s not about what these companies did, it’s about what they will do. So lets look at where the trends are headed.

Revenue growth

Revenue growth is the key driver of shareholder return in the long-term. Intuitively, that seems logical because if revenue is not increasing then profit and free cash flow cannot increase. And we know that profit and free cash flow drive company value.

In the short-term a company can increase profit and free cash flow by cutting expenses and cash outflows, but it cannot do that forever.

The graph below shows the results of a study conducted by the Boston Consulting Group. It confirms our intuition that revenue growth drives shareholder return in the long-term. In the short-term, other factors may drive shareholder return, but revenue growth is still important.

Analysis

For the analysis below, we have the share price and revenue growth rate graphs for each company.

Each of these companies is highly-rated, meaning that they have high valuation multiples. For comparison purposes, the S&P 500 P/E ratio is at a level of 24.59. It is up from 23.46 last quarter and up from 19.69 one year ago.

Apple

Apple is on a forward P/E ratio of 30. As you can see from the graph, Apple’s growth seems to come in spurts - probably accelerating with the release of new products. What we see is that most recently Apple has three quarters of declining revenue. Also, if we look at the longer term revenue growth rate (not shown here), it has been declining for more than a decade.

Microsoft

Microsoft is on a forward P/E ratio of 33. Microsoft’s growth has declined recently, but it is stable at 7.5%. Microsoft is in the Extraordinary Companies portfolio, so stable is good for us.

Google

Google is on a forward P/E ratio of 20, but the growth rate has dropped quite significantly to 5.3%.

Amazon

Amazon is on a forward P/E ratio of 45. The growth rate has dropped quite significantly to 10.32%. Amazon is perplexing, it recently had negative free cash flow, it has high amounts of stock-based compensation and its operations do not create a lot of shareholder value. But it is a highly-rated stock.

Nvidia

Nvidia is on a forward P/E ratio of 25. The growth rate is accelerating. Nvidia is this year’s market darling, but semiconductors are cyclical. The P/E ratio may not look too high for a company experiencing 57% growth, but it will change as the company goes through this cycle.

Meta (Facebook)

Meta is on a forward P/E ratio of 20. The growth rate was negative and has now recovered to 7.5%. This is okay, but not great considering how fast it was growing a few years ago.

Tesla

Tesla is on a forward P/E ratio of 70. The growth rate has dropped slightly, but still remains high at 28%.

Conclusion

The super-high returns of the past from the Magnificent Seven does not seem likely since the main driver of long-term returns (i.e. revenue growth) is slowing.

This does not mean that these companies are bad investments. However, I would suggest examining your expectations about the future performance before jumping in.

For a number of them, the high growth period is clearly over. For the others, perhaps there will be solid returns. For Nvidia, beware of the cyclicality. For Tesla, take note of the high valuation.

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