During periods of heightened volatility and uncertainty, it's not uncommon for investors to seek the safety of profitable, time-tested, industry-leading businesses. While the FAANG stocks have fit the mold for the past decade, it's the "Magnificent Seven" that have found their spot on the pedestal in 2023.
When I say Magnificent Seven, I'm referring to (in order of largest to smallest market cap):
- Apple (AAPL 2.90%)
- Microsoft (MSFT -1.28%)
- Alphabet (GOOGL -3.15%) (GOOG -3.06%)
- Amazon (AMZN 0.54%)
- Nvidia (NVDA -0.16%)
- Meta Platforms (META -2.80%)
- Tesla (TSLA 14.86%)
Image source: Getty Images.
What makes these seven stocks so special is their sustained competitive advantages and/or seemingly impenetrable moats.
- Apple controls more than half of U.S. smartphone market share and has the most robust capital-return program among publicly traded companies.
- Microsoft's Windows is still the world's dominant desktop operating system, while Azure is the global No. 2 in cloud infrastructure service spending.
- Alphabet's Google has accounted for at least 90% of global internet search share since March 2013, while streaming platform YouTube is the world's second most-visited site.
- Amazon brings in roughly 40% of all U.S. online retail sales, and is the parent of leading cloud infrastructure service platform, Amazon Web Services (AWS).
- Nvidia's graphics processing units have a virtual monopoly, for the moment, in artificial intelligence (AI)-accelerated data centers.
- Meta Platforms owns the top social media "real estate" and attracted nearly 4 billion unique monthly active users during the third quarter.
- Tesla is North America's leading electric-vehicle (EV) maker and the only EV pure-play generating a profit.
Additionally, the Magnificent Seven are outperformers. As you can see, they've left the benchmark S&P 500 in the dust this year.
The traditional P/E ratio isn't the best way to value the Magnificent Seven stocks
But just because these seven stocks are outperformers, it doesn't mean their outlooks are equal. There are some wide valuation variances among the Magnificent Seven, with one company standing out as the clear best value.
While most investors lean on the price-to-earnings (P/E) ratio as the traditional valuation determinant, it has its drawbacks for high-growth companies. Namely, the Magnificent Seven tend to reinvest a lot of their operating cash flow back into high-growth initiatives. Therefore, it's a much smarter approach to compare the Magnificent Seven relative to their future cash flow instead of their future earnings.
Here's how the Magnificent Seven stocks compare when examined relative to their forward-year cash flow:
- Meta Platforms: 9.54 times estimated forward-year cash flow
- Amazon: 10.83
- Alphabet (Class A shares, GOOGL): 12.65
- Microsoft: 18.78
- Apple: 20.91
- Nvidia: 22.95
- Tesla: 37.96
As you can see, Tesla is far and away the priciest stock of the bunch. With its operating margin declining, Tesla is going to have a hard time winning over fundamentally focused investors.
Nvidia and Apple aren't inexpensive, either. Nvidia could struggle to meet investors' lofty AI expectations, while Apple is contending with a modest decline in sales and profits in fiscal 2023 (Apple's fiscal year ends in late September).
While Alphabet and Amazon are both historically inexpensive relative to their cash flow, it's social media stock Meta Platforms, which has tripled off of its 2022 bear market low, that's the cheapest Magnificent Seven stock.
Image source: Getty Images.
Meta Platforms is the unquestioned best deal among the Magnificent Seven
The primary reason Meta Platforms is cheap is because of uncertainty surrounding the health of the U.S. economy. Meta has generated a whopping 98.4% of its revenue from advertising since this year began, and businesses aren't shy about reducing their ad spending when the first hint of economic weakness arises.
The other concern that's kept Meta's valuation at bay is the company's ongoing losses from Reality Labs -- the segment focused on metaverse ambitions and virtual/augmented reality devices. CEO Mark Zuckerberg envisions Meta being an on-ramp to the metaverse in the years to come, and he's not afraid to deploy the company's treasure chest of cash to make it happen. Reality Labs has produced a nearly $11.5 billion operating loss through the first nine months of 2023.
However, neither of these headwinds is particularly worrisome. A wider-lens look at Meta's operating model shows that it's as strong as it's ever been -- even with steep losses from Reality Labs.
As I alluded earlier, Meta's social media assets are second to none. Facebook is the most-visited social site globally, while WhatsApp, Instagram, and Facebook Messenger are, collectively, some of the most-downloaded social apps globally. There's also Threads, which took just five days to top 100 million users following its early July launch.
Meta attracted 3.96 billion unique monthly active users during the third quarter, which represents more than half of the world's adult population. There isn't a social media platform that offers more eyeballs to advertisers, which is what affords Meta such exceptional ad pricing power in most economic climates.
Something else to consider is that the U.S. economy spends a disproportionate amount of time expanding, relative to contracting. Whereas no recession following World War II has lasted longer than 18 months, a majority of expansions over the past seven-plus decades have lasted for multiple years. The key point here being that ad spending tends to grow in lockstep with the U.S. economy over long periods, which is great news for an ad-driven company like Meta.
Meta's balance sheet and cash flow also afford risk-taking that most social media companies can't match. It closed out September with $61.1 billion in cash, cash equivalents, and investments, and has generated $51.7 billion in net cash from operating activities in just nine months. This is more than enough capital to absorb losses from Reality Labs and potentially set the Meta up for a bright future as an on-ramp to the metaverse.
Despite tripling since the bear market low last year, Meta remains a phenomenal value for investors with a long-term mindset.
