The Magnificent Seven tech stocks, comprising Nvidia, Tesla, Apple, Meta Platforms, Alphabet, Microsoft, and Amazon.com, are currently riding a wave of strong profit growth expectations, largely fueled by their leadership in AI-related technologies. Sales are soaring across most of these companies, driven by the adoption of AI software in various sectors. Nvidia benefits from the increased demand for its chips due to the popularity of AI software from Microsoft, Alphabet, and Amazon. Meta Platforms is gaining market share in digital advertising through AI-driven enhancements. Even Tesla and Apple are seen as players in the AI space as they work on self-driving cars and undisclosed AI strategies, respectively.
Analysts foresee aggregate annualized net income growth of just over 15% for the Magnificent Seven over the next three years, surpassing the S&P 500’s expected growth rate in the low double digits. This expectation underscores the perception that these companies are still considered growth stocks. As long as the market continues to value their near-term earnings at current levels, these stocks have the potential to outperform the broader market, aligning with their earnings growth. However, it’s important to note that there are factors that could cause their earnings to grow slower than anticipated, which investors should consider.
While earnings for the Magnificent Seven tech stocks are expected to increase, there’s a reasonable probability that their growth will slow down. If the market focuses on this risk, it could lead to a drop in the valuations of these stocks, hindering their share-price performance. Signs of slower growth may prompt analysts to swiftly reduce their earnings forecasts, further depressing stock prices.
The reality is that profit growth for these companies goes through cycles. In early 2017, net income growth for the trailing 12-month period was 35%, but it slowed to 15% in 2019 as various trends matured. In 2020, earnings growth surged to nearly 45% due to the pandemic-induced shift to remote work and online activities, but this growth was unsustainable and tapered off as the pandemic’s effects waned, compounded by Federal Reserve interest rate hikes to combat inflation in 2022.
Given these dynamics, it’s crucial to consider when earnings growth will next slow down. While AI adoption is still in its early stages, overall earnings growth in this area is expected to remain high for years. However, a more pressing concern is the potential impact of Federal Reserve interest rate hikes on consumer demand, which could affect sales of digital advertising, smartphones, and electric vehicles.
With earnings growth for the seven companies reaching 30% over the past 12 months, nearing recent peaks, there’s growing concern about the sustainability of their profit cycles. Trivariate’s Adam Parker highlighted this concern, suggesting that now may not be the best time to buy these stocks.