April 20, 2024

What’s next for the Magnificent Seven?

Tired of the raids of local bandits, the farmers of a poor Mexican town hire a group of gunmen from across the American border to protect them. This is the plot of the 1960 film classic, The seven magnificents.

Last year, the same epithet was attributed to the seven stocks that produced the most growth in global stock markets. They also offered protection to savers who saw their wealth devastated by inflation. But are they up to the job in the long run? And how could this story end?

Investors love slogans for stocks and burning markets. around time The seven magnificents was drawing movie crowds, the markets were led by what became known as the “Nifty Fifty.” Many of them were growth stocks, including the hot technology companies of the time (Xerox, IBM and Texas Instruments), while others belonged to consumer companies such as Coca-Cola and Procter & Gamble.

Investors saw the group as a simple, reliable list of “hot stocks.” They were so good that “nothing bad could happen to them.” And that meant that no price was considered too high to pay. By the early 1970s, the average price-to-earnings multiple had reached 50 times: not so nifty!

When the oil crisis hit and markets crashed, this group fell much further than most: well-liked, overvalued, and open to profit-taking. That said, even though one or two of the Nifty Fifty stocks have failed over the last half century, buying and holding this set would probably have worked out quite well, especially if one had bought at any time other than the valuation bubble of 1971-72. . Most holdings have generated high returns to date. The lesson is that ratings matter.

In 2001, the acronym BRICS was coined to refer to the emerging markets that were considered to have the best growth prospects: Brazil, Russia, India and China. Supporting these economies has been less successful for investors. In stock market terms, only India has consistently performed particularly well.

China had a good decade in the 2000s, but stock returns have been poor over the past five years, even though the economy is now the world’s second largest. The terrible returns on Russian stocks underscore the political risk that can come with investing in some emerging markets.

In short, these labels are no guarantee of investment success. So what’s up with the Magnificent Seven? Looking ahead, they can be divided into two groups: those who most obviously benefit from artificial intelligence and those who do not.

AI beneficiaries offer AI-enhanced infrastructure or services (and in the case of Microsoft, both). On the infrastructure side, AI will require powerful chips and enormous storage. Nvidia leads advanced semiconductor manufacturing; Microsoft and Amazon offer cloud hosting.

In terms of AI services, Meta and Alphabet offer great language models: Meta’s LlaMA and Alphabet’s PaLM. The latter is used to power Google Bard, an experimental AI chatbot that can draft article outlines, summarize texts, and translate.

Meanwhile, Microsoft is increasingly integrating AI into its core programs, such as Word, Outlook and PowerPoint, to improve productivity, and using it to improve its search engine, Bing, which until now has been a companion to Google.

If these services prove as popular as expected, a number of second-tier companies could also grow rapidly. They include cybersecurity vendors, such as Palo Alto Networks and CrowdStrike, and semiconductor designers and testers, such as Synopsys and Advantest. Although many of these stocks trade at high current sales multiples (and higher earnings multiples), I own small positions in most of them.

The strange ones are Apple and Tesla. Currently, Apple is not seen as a big beneficiary of the AI ​​boom. If AI allows non-IT professionals to improve and adapt applications without having to hire a coder (as Windows did when it first emerged), we could see an increase in the value of a variety of consumer applications, such as those from the Apple App Store.

As an early example, if you’re impressed by new versions of the Bing search engine, you might imagine how AI could improve other apps you use. But will that make a big difference to Apple’s revenue? I could be wrong, but I doubt it.

Tesla has little in common with others. It makes electric cars and faces increasing price competition from other manufacturers, especially Chinese ones.

The Magnificent Seven’s stock prices have already risen sharply, largely due to AI hopes. In the next fortnight we will have earnings updates for everyone except Nvidia. Those results will be judged in two ways. Is revenue growth showing signs of a multi-year boost thanks to AI? Or, if not, is the CEO’s outlook statement still confident that momentum is on the way?

The price/earnings (and often price/sales) ratios of these stocks may seem high, but not as exaggerated as those of Big Tech stocks in 2000. In fact, a few years of double-digit sales growth could easily justify the current valuations of those stocks. who capture key roles in this new market.

Meanwhile, the rest of the global stocks have declined over the past year and are likely to now offer better value for money for investors, especially if the threat of inflation is easing and economies are recovering.

The winners in The seven magnificents The film was the farmers, who saw the bandits defeated. They got good value for money for a while, but eventually concluded it was time to move on. Investors may feel the same.

For those who previously invested in the Magnificent Seven, it seems prudent to take some profits and reallocate stocks with much lower valuations to other parts of the world. I don’t think it’s time to sell this topic. AI will improve productivity in a wide range of industries. While the focus is currently on AI enablers, there will be many other companies that will benefit from its effects. This is a good year to look for those overlooked opportunities.

Simon Edelsten is a former fund manager

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