There are six mega cap stocks which are ‘profit magnets’, but they all share a specific vulnerability, according to David Jane of the Premier Miton macro thematic multi asset team.
In a recent piece of commentary Jane (pictured) laid out why Apple, Amazon, Meta Platforms, Microsoft, Alphabet and Nvidia remain so appealing, but are not without risk for investors. The stocks make up most of the ‘Magnificent Seven’, with Tesla left out.
“Since 2017, six companies have gone from circa 5% of worldwide market capitalisation to now just short of 20%, he said. “At the same time, they have gone from 4% of worldwide profits to an estimated 14% in the current year. An astonishing outcome and one that if you had predicted it would have been hugely profitable.”
Jane noted that earnings growth for these companies has been outstanding, but so has the valuation expansion.
“The market is expecting for them to account for an ever-growing percentage into the future. Which implies that the rest of the world is expected to continue its decline as a portion of profits.
“These companies are obviously hugely successful, they have become crucial to the world economy, providing core services for almost all consumers and businesses”
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The firms have created monopolies, or at least dominant positions in their markets, Jane explained. “There is a lot to like. From this position potentially, they might be able to continue to suck in profits from the rest of the world economy; an unregulated monopolistic utility position at the core of the world economy is a nice place to be.”
Jane warned however that there is a potentially negative side to these stocks which is perhaps not fully understood.
“These companies’ business models are changing,” he said. “Capital expenditure as a percentage of operating cash flow has gone from 28% to 38% at Meta from 2017 to 2023 and from 20% to 38% at Microsoft. There is a similar trend elsewhere among these mega cap companies.
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“This is because the ‘AI’ trend requires a huge amount of capital expenditure in data centres. They are no longer competing with product development and software; they see future success from massive capital investment in processing capacity. This capital cycle has only just begun.”
“This is a major change for these industries. AI needs to be a major revenue generator to justify the level of capital investment,” Jane continued.
“Unfortunately, thus far there is little evidence of any viable revenue model that justifies the expenditure. Even if this arises, it appears these businesses have shifted to a capex heavy model, where success come less from innovation and more from the ability to spend more than your peers.
“If that is the case, in the long term, margins and returns will be greatly eroded over time, despite the huge market concentration.”
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