Top Tech Takeaways – Companies Have to Spend Money to Make Money
What happened last week?
The S&P 500, Dow and Nasdaq shed -1.37%, -0.15% and -1.50% after a two-day rout on Wednesday and Thursday on earnings disappointments before sentiment improved on Friday.
The economy created only 12K jobs in November, the lowest since 2020, with Hurricanes and a strike sited as factors.
To say last week was a big one for Tech earnings is an understatement with five of the Magnificent 7 stocks, and many more, reporting their third quarter results. So far, we’ve heard from 348 of the S&P 500 companies and the aggregated results show firms beating consensus earnings and sales estimates collectively by 7.1% and 1.5%, respectively.
What does this mean for investors?
Dispersion between winners and losers is usually very wide in dynamic, innovative industries. We suspect that the intense focus on big tech may have driven too wide a performance divergence, however, creating potential opportunities for undiscovered smaller firms. There can be no promises made about individual firm prospects, but history suggests smaller, profitable innovators may be systematically undervalued compared to large firms.
3 Things to Know
Tech’s “Magnificent 7” Beats EPS Consensus for Quarter
With just hours left to the US Presidential election, the Nasdaq and Nasdaq 100 made new record highs following a summer consolidation.
Shrugging off bipartisan regulatory threats, this was powered by record profits, not political hot air. The early week rise was followed by a round of profit taking last Thursday as investors refocused on the rapid spending increases from the largest tech platform companies to cover costs needed to develop AI services.
Markets reversed once again last Friday as good corporate news and a hurricane-distorted employment report drove modest declines in bond yields.
As mentioned, we’ve heard from 348 of the S&P 500 companies and the aggregated results show firms beating consensus earnings and sales estimates collectively by 7.1% and 1.5%, respectively.
Zeroing in on Technology, earnings and sales are topping the forecasts by 1.6% and 1.0%, and the sector is expected to generate faster earnings growth than the overall market in 2024–2026.
While share prices can fluctuate in the shorter-term, especially in the richer corners of the sector, the longer-term earnings outlook and a wave of innovation appear supportive.
Along with Healthcare, the greater “Tech” sector is one of just two that have seen its earnings and market cap share of the total grow over time. We believe this reflects the ongoing digital transformation of the economy underway which we consider to be an unstoppable trend.
AI Bets and Direct Competition Are Concerns
AI spending plans were in focus, as companies across virtually every industry seek to leverage their data to enhance sales and make productivity improvements in the years ahead.
Three of the reporting Mag 7 lie at the center of the cloud computing infrastructure so critical to bring this about.
Collectively, these companies, based on their reporting, have capital spending plans totaling $179 billion in 2024 with the prospects of continued growth but likely at a moderating rate in 2025. This should translate into slowing revenue growth of leading AI chip players as a result.
In offering new AI services, we’ve long been concerned that several of the so-called “Magnificent 7” — the largest firms with tech-related businesses — might compete more directly with each other than they do today. And of course there are others: OpenAI, the developer of ChatGPT, isn’t even a public company.
With that said, it’s encouraging to see an accelerating return on investment of AI user cases among mega tech and their clients, with operating margins on AI revenue continued to ramp, likely supporting further investment.
Companies with efficient capex management and transformation to profits have been greatly rewarded by the markets, while those who showed weaknesses, even for temporary reasons, experienced negative price reactions after the reports.
“Magnificent 7” EPS Consensus Forecast for 2024: 28.2%
While share prices can fluctuate in the shorter-term, especially in the richer corners of the sector, the longer-term earnings outlook and a wave of innovation appear supportive. Along with Healthcare, the greater “Tech” sector is one of just two that have seen its earnings and market cap share of the total grow over time.
We believe this reflects the ongoing digital transformation of the economy underway which we consider to be an unstoppable trend.
Overall, EPS gains for the Mag 7 were 43.3% in 2023. Consensus sees a 28.2% EPS gain in 2024 and 18.3% rise in 2025.
See our weekly CIO Strategy Bulletin for more details