(Bloomberg Opinion) — Growth prospects for the group of companies called the Magnificent 7 are still above average, but they are no longer magnificent. Wall Street consensus forecasts suggest that, in total, the seven large-cap companies will outperform the S&P 493 next year, and yet investors continue to pay a premium to own them. That alone suggests it may be time to pull their weight in the wallet.
Note that the group's net income growth is expected to ping pong around 20% from here on out, according to forecasts compiled by Bloomberg Intelligence. Other members of the S&P 500 Index are expected to see growth increase toward 16% by the end of next year. The point is that the Mag 7 group trades at an average valuation of about 30 times forward blended earnings, while other large-cap stocks in the S&P 500 Index trade at an average of 19.5 times. How long should we expect investors to pay more for increasingly similar performance?
To a large extent, the next two years will depend on what happens with artificial intelligence and whether the hype around its potential to disrupt the way we do business it is stable. Nvidia Corp. has become the most exciting stock in the world providing the proverbial picks and shovels for the early days of the AI boom. Apple Inc., Microsoft Corp., Amazon.com Inc., Meta Platforms Inc. and Alphabet Inc. have gotten all the excitement by investing heavily in bringing the technology to companies and consumers, in many cases sending their capital expenditures directly into Nvidia's coffers. All companies have become interdependent and interconnected, and their high valuations depend on the idea that the spin will continue to spin. (More on Tesla Inc. with strange people later.)
Some people say it may be slowing down already. While generative AI models continue to dazzle, they are also plagued by errors and imperfections, and marginal improvement for extra dollars and the data isn't quite what it used to be. Conceivably, AI could follow the path of the Internet and other innovations described in Gartner's Noise Cycle: Early successes and big dreams give way to a later period of disappointment and even some business failures before a more sustainable revolution can finally take hold. In the dot-com bubble, for example, Amazon.com emerged triumphant from the ashes of many other e-commerce companies.
High expectations may also collide with other threats to the tech and communications giants. Alphabet shares fell last week after the Justice Department revealed it would try to force the company to sell its Chrome browser. Apple, which has faced antitrust scrutiny of its own, is also grappling with challenging iPhone sales in China and the threat that President-elect Donald Trump will launch a new trade war that could disrupt its supply chain.
Tesla, I'll admit, is a trade in itself that isn't directly related to its Mag 7 peers. Lately, it's been trading not on incredible earnings growth, but on the promise of robotaxis that don't even exist on the market yet. and CEO Elon Musk's cozy relationship with Trump (which just might help him clear regulatory hurdles to Tesla's autonomous driving ambitions). At 108 times forward earnings, Tesla is the riskiest investment in the Mag 7 basket and perhaps the only true diversifier.
Admittedly, all of these companies offer a lot to be excited about, too, and many investors will conclude that the potential for surprise is too great to completely miss.
Indeed, 2024 itself has fared much better than analysts predicted some 12 months ago. But it would also make sense for investors to take some profits in those companies, as Warren Buffett, the investor known as the “Oracle of Omaha,” has done with his shares in Apple. Currently, the companies make up nearly a third of the S&P 500 by weighting — and thus a bloated portion of many Americans' retirement savings. This feels like a little too much for your future self to trust a group of richly priced companies all used the same narrative.
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Jonathan Levin in (email protected)