What will 2024 bring for the Magnificent Seven? Part 2
The promising ones (Microsoft, Amazon, Meta, Alphabet)
You asked for it: Back by popular demand, I published my opinion on the crash-prone stocks of Apple, Tesla and Nvidia in Part 1 of this article last week. Not all readers liked it. I was accused several times of lacking depth in my analysis.
And indeed, my critical contributions to these Big Tech stocks are not exactly masterpieces of stock analysis. But that is not my claim in this case. I am not invested in these companies but I do have a strong opinion about big tech, as do countless other market observers.
Sometimes, in order to make an assessment of such giant companies, it is enough for me to simply observe the valuation, the technology and market development, and the sentiment in the stock market. As an independent investor who sometimes likes to be anti-cyclical, I often take a more critical view than most sell-side analysts. I think it's important to sound a note of caution when necessary. Fans of Apple, Tesla and Nvidia may forgive me.
This second part of my assessment of The Magnificent Seven will not be an analyst's masterpiece either. Once again, in this case I will only express my opinion. Because many of you are interested, as I can see from the numerous enquiries.
If you prefer to read the more detailed stock analysis you are used to getting from me on my portfolio stocks, I can well understand that. And in the coming weeks, my writing will again focus on such investment cases related to second- and third-tier tech stocks, I promise!
But first, here is my current assessment of Microsoft, Amazon and Meta:
Microsoft
Microsoft MSFT 0.00%↑ is being hailed as THE big winner of the AI revolution. And indeed, it is a great management achievement how CEO Satya Nadella has managed to forge a forward-looking, truly strategic partnership with Sam Altman and OpenAI over the past 12 months.
For a while, it looked as if Sam Altman was going to move to Microsoft completely. The fact that it didn't work out in the end is a good thing for Microsoft, at least in terms of the greater innovative power of OpenAI as an independent company.
As the operator of the second largest public cloud, Microsoft's growth prospects have been further enhanced by the OpenAI alliance. I think it is quite possible that Microsoft Azure, with a current market share of 25%, will be able to catch up with Amazon's AWS (currently 30%) in the coming years.
The AI euphoria surrounding Microsoft is huge and Microsoft shares have benefited greatly from this AI boom in 2023. The stock is trading at an all-time high and has just dethroned Apple as the world's most valuable company.
Analysts expect Microsoft to grow by almost 15% in fiscal 2024, which ends in June, and by the same amount in subsequent years. I think this is very ambitious, as it means absolute revenue growth of over 30 billion USD in just one year!
At the same time, analysts expect Microsoft's already extremely high profitability to increase even further, with EBITDA margins approaching 50%. I don't really understand how this is going to work: The revenue growth is supposed to come from the new AI products. However, these initially consume an incredible amount of expensive resources (I already pointed out the price explosion for Nvidia chips in part 1). Where is the margin growth going to come from for a company that has optimised its profitability for years?
After the price rally in 2023, the valuation of Microsoft shares is now very sporty again. The current all-time highs have been largely driven by an increase in valuation. The P/E ratio has risen from 28 to 38 over the past 12 months, while the cash flow multiple has risen even more, from 28 to 45.
Microsoft stock is priced as if its highly profitable revenue growth will accelerate to 20% a year. Despite all the AI euphoria, I don't think this is realistic.
Perhaps the tech giant can indeed significantly increase revenue per knowledge worker in the AI age. But at the same time, the productivity gains that can be achieved through AI are likely to have a cannibalising effect. Many companies will simply need fewer employees, and therefore fewer Microsoft licences, in the AI age.
Microsoft shares are already anticipating a lot of good news in 2024 and are "priced for perfection". What if the new AI copilots don't sell as well as expected? In any case, the share price has reached a fairly high level and disillusionment after the AI hype could lead to a significant correction.
Conclusion:
I do not see a good risk/reward in investing in Microsoft at the moment.
Amazon
Although Amazon AMZN 0.00%↑ is celebrating its 30th birthday this year (hard to believe), until two years ago it was still in land-grab mode: Jeff Bezos and his successor as CEO, Andrew Jassy, prioritised revenue growth and the conquest of new markets over profitability and cash flow growth.
This Amazon strategy worked for many years and was long celebrated by investors. However, their preferences changed rather abruptly with the turnaround in interest rates, and in 2022 Amazon's shares were severely punished by a lack of profits, losing more than 50% of their value.
Since then, a new wind has been blowing at Amazon: in 2023, the management was extremely cost-conscious and did not shy away from unpopular cost-cutting measures in order to bring the still loss-making units, such as the streaming platform Twitch, to profitability as quickly as possible.
This success is already clearly reflected in Amazon's latest financial results: The eCommerce segment recently reported an impressive improvement in operating margin. And despite the weakening AWS cloud growth, Amazon will be able to report big leaps in profitability by 2023, together with double-digit revenue growth.
Analysts expect earnings per share to be around 2.70 USD in 2023, after a loss in the previous year, and to more than double over the next three years.
Further margin improvements in e-commerce are expected to contribute to this. This will be driven by booming advertising revenues and rising income from high-margin fees from third-party sellers on the Amazon platform.
AWS should complete its consolidation phase in 2024 and, like Microsoft Azure, should ultimately benefit from customers bringing more and more AI applications to the cloud.
In contrast to Apple and Microsoft, Amazon is still far from being 100% focused on profitability, even after its impressive change of course in 2023. Analysts rightly see great potential for further significant increases in cash flow and profits in the coming years.
Amazon's visually high P/E ratio of over 50 for 2023 can therefore be deceptive; if the share price remains the same, it is likely to fall towards 20 by 2026. This does not necessarily sound like a bargain (and it is not), but it is not absurdly high either.
In recent years, there has been much speculation about a spin-off of AWS. In fact, such a spin-off would probably be the best way to create additional value for Amazon shareholders.
Background to this thesis: AWS would also have a good chance of becoming one of the world's most valuable companies as an independent company. AWS is expected to break the 100 billion USD revenue barrier in 2024. Last quarter, AWS already achieved an operating margin of 30%. It is realistic to expect AWS to achieve EBIT of around 30 billion USD in 2024. At a multiple of 20-25, AWS would be worth 600-750 billion USD, which is about half the enterprise value of the entire Amazon group today.
This would put AWS ahead of even Tesla in terms of valuation, and this enterprise value would easily place it in the top 10 companies in the world in terms of enterprise value.
Conclusion:
Overall, Amazon has been a good long-term holding for me for years. Nothing has changed in this respect. No more and no less.
Meta Platforms
In January 2022 I sold my META 0.00%↑ shares with a nice profit after holding them for 5 years. The decision was right at the time; in the 11 months following my sale, the stock price fell by over 70% as the Metaverse hype died down.
Unfortunately, I did not correctly anticipate the rapid recovery of the Meta stock that followed in 2023, which was able to make up for all these interim losses and is now trading at its 2021 all-time high again.
There are good fundamental reasons for this comeback: Mark Zuckerberg has stopped or at least significantly slowed down the wrong turn into the metaverse that he started in 2021 and radically reduced the planned investments in the topic. It remains to be seen whether augmented reality will gain new momentum with Apple's new Vision Pro devices. But the Meta Group is now well prepared even if our future does not take place behind AR/VR glasses as expected (which I still assume it will).
A lot has changed in the short-lived social media landscape since I exited the meta stock two years ago: Elon Musk took over Twitter, renamed it X, and his company policies angered many advertisers and drove them into the hands of Mark Zuckerberg. Meta seized the opportunity and launched a real alternative to X with the short messaging platform "Threads". Under the handle @stwboerse, I am now active on Threads (almost) every day.
TikTok has continued to gain market share, with over 150 million active users in the US and over 20 million in Germany. Word is now also getting around in politics: it cannot be in the interests of the Western world if a company controlled by China uses a secret algorithm to determine which influencers affect the younger generation with which messages.
In my view, the risk of the Meta Group being forcibly broken up by the US regulator has decreased over the past two years, as Meta is less dominant than before due to competition from TikTok.
The rapid rise in Meta's share price in 2023 is fundamentally driven by an impressive turnaround in its business performance, achieved despite a weakening advertising market. Meta's revenues will grow by around 15% in 2023 and its EBITDA margin will reach well over 50% (after stagnating revenues and an EBITDA margin of 36% in 2022). Analysts expect earnings per share to rise by two-thirds to over 14 USD in 2023, equivalent to a P/E of 25.
That sounds both realistic and fair for a company that I believe will continue to deliver double-digit revenue growth and above-average earnings growth for years to come. Unlike Apple and Microsoft, Meta Group is far from cost-optimized, and the monetization potential of its own platforms ( WhatsApp and Threads) is far from exhausted.
Conclusion:
For me, Meta Platforms is the most interesting stock in the Magnificent 7 alongside Alphabet.
Alphabet
Which brings us to Alphabet GOOG 0.00%↑ , the only remaining big tech stock in my model portfolio. Alphabet shares are also trading close to their 2021 highs again after a rapid rise in stock price.
I will refrain from providing a new assessment at this point, but refer to my last update on Alphabet shares from October 2023. I plan to provide an update of Alphabet again after the company's financial results scheduled for 1 February 2024.
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*Disclaimer:
The author and/or related persons or companies own shares of Alphabet and Amazon. This article is an expression of opinion and does not constitute investment advice.