Despite economic uncertainty, Wall Street delivered phenomenal returns to patient investors in 2023. The iconic Dow Jones Industrial Average climbed to a record high, while the benchmark S&P 500 and innovation-fueled Nasdaq Composite rallied 24% and 43%, respectively, by the time the curtain closed.
Although the rally became a bit more broad-based in the final two months of the year, the outperformance of the "Magnificent Seven" is widely credited with lifting the broader market higher.
Image source: Getty Images.
When I say Magnificent Seven, I'm referring to what have consistently been the seven largest publicly traded companies in the U.S. by market cap:
- Apple (AAPL 2.48%)
- Microsoft (MSFT -1.00%)
- Alphabet (GOOGL -3.37%) (GOOG -3.33%)
- Amazon (AMZN 0.75%)
- Nvidia (NVDA 0.03%)
- Meta Platforms (META -2.41%)
- Tesla (TSLA 15.31%)
Apple clocked in as the "worst" of the bunch with a 48% return in 2023, while Tesla, Meta, and Nvidia rallied 102%, 194%, and 239%, respectively.
What investors seem to appreciate about the Magnificent Seven stocks is their undeniable competitive advantages.
- Apple's iPhone is responsible for more than half of all U.S. smartphone market share, and its share repurchase program is unmatched by other public companies.
- Microsoft's Windows is still the undisputed leader in desktop operating systems, while Azure has gobbled up a 25% share of global cloud infrastructure service spending.
- Alphabet's Google accounted for close to 92% of worldwide internet search share in December. Meanwhile, streaming platform YouTube (also owned by Alphabet) attracts more than 2.7 billion unique viewers each month.
- Amazon's e-commerce marketplace brings in an estimated 40% of U.S. online retail sales, with Amazon Web Services (AWS) leading the world in cloud infrastructure service spending share (31%), as of the third quarter.
- Nvidia is the infrastructure backbone of the artificial intelligence (AI) revolution. Nvidia may account for more than 90% of all graphics processing units (GPUs) used in high-compute data centers in 2024.
- Meta Platforms owns the world's top social media "real estate." Facebook is the most-visited site globally, with WhatsApp, Instagram, and Facebook Messenger collectively (with Facebook) attracting close to 4 billion monthly active users.
- Tesla is North America's leading electric-vehicle (EV) manufacturer and the only pure-play EV company that's comfortably reached recurring profitability.
In spite of these competitive edges, the outlooks for these seven stocks could differ dramatically in the new year. Whereas one Magnificent Seven stock is effectively cheaper than it's ever been as a publicly traded company, another expensive highflier appears poised for a reality check.
The Magnificent Seven stock to buy hand over fist in 2024: Amazon
Among the seven industry titans listed above, the one investors can confidently buy hand over fist in 2024, and likely hold for many years to come, is e-commerce company Amazon.
The biggest potential headwind for Amazon in the new year is the possibility of a U.S. recession taking shape. A couple of money-based metrics and predictive indicators suggest a downturn is likely. Since Amazon generates so much of its revenue from its online marketplace, a recession would be expected to slow consumer spending.
But there are two important things to understand about this headwind for Amazon. First, recessions are historically short-lived. Only three of 12 U.S. recessions following World War II have surpassed 12 months, and none have made it past 18 months. Betting on economic expansion has always been a winning move for patient investors.
Secondly, but most important, Amazon generates very little of its operating cash flow and operating income from its mammoth online marketplace. Even if online retail sales were to taper a bit, it would likely have a negligible impact on the company's cash flow and bottom line.
What can carry Amazon's stock to new highs in 2024 is the company's high-growth ancillary operating segments, which are led by AWS.
As noted, AWS accounts for nearly a third of worldwide cloud infrastructure service spending. Cloud service margins can run circles around the razor-thin margins associated with online retail sales. As a result, AWS is consistently responsible for between 50% and 100% of Amazon's operating income despite generating only a sixth of the company's net sales. With enterprise cloud-service spending still ramping up, AWS looks to have a long runway of double-digit growth ahead of it.
Don't overlook Amazon's advertising services segment, either. This is a company that's drawing more than 2 billion people to its site on a monthly basis, many of which are motivated shoppers. This puts the ball in Amazon's court when it comes to ad-pricing power. Not surprisingly, Amazon's advertising services segment has delivered at least 21% year-over-year constant-currency sales growth over the past eight quarters (two years).
Although some fundamentally focused investors are going to be turned off by Amazon's astronomical trailing-12-month price-to-earnings (P/E) ratio of 75, the traditional P/E ratio is a terrible way to value cutting-edge companies like Amazon that are reinvesting the bulk of their operating cash flow back into their business. Valuing Amazon relative to its cash flow is, therefore, a much smarter approach.
Throughout the 2010s, Amazon was regularly valued at a multiple of 23 to 37 times cash flow. It can be scooped up right now for less than 13 times forecast cash flow in 2024. With the exception of the 2022 bear market, it's the cheapest Amazon has traded, relative to its future cash flow, since going public in 1997.
Image source: Getty Images.
The Magnificent Seven stock to avoid like the plague in the new year: Nvidia
On the other side of the coin, semiconductor giant Nvidia has all the hallmarks of a stock to avoid like the plague in 2024.
I'll absolutely give Nvidia credit where credit is due for more than tripling in value last year. With interest in AI soaring, Nvidia's A100 and H100 GPUs quickly became staples in AI-accelerated data centers. Considering that chip fabrication juggernaut Taiwan Semiconductor Manufacturing is significantly beefing up its chip-on-wafer-on-substrate capacity, Nvidia shouldn't have any trouble delivering more of its AI-driven GPUs in the quarters to come.
So, what's the problem? Pricing power, growing competition, regulatory headwinds, and history all come to mind.
In Nvidia's fiscal 2024, which ends later this month, the company's sales are expected to climb by approximately 119% from the previous year. Almost the entirety of this growth can be traced to the company's GPUs from its data-center segment. More specifically, it's being driven by jaw-dropping pricing power.
Through the first six months of fiscal 2024, Nvidia's cost of revenue actually declined from the prior-year period. Through the first nine months, it's only jumped by an aggregate of 20%. What this tells investors is that A100 and H100 scarcity is what's driven Nvidia's sales growth. Ironically, ramping up its own production in the current calendar year is liable to sap its pricing power and adversely impact its gross margin.
To build on this point, competition in AI-focused GPUs is bound to pick up. Advanced Micro Devices introduced its MI300X AI-GPU last year and intends to roll it out in a big way throughout 2024. Likewise, Intel plans to bring its Falcon Shores GPU to market as a direct competitor to Nvidia's A100 and H100 chips in 2025. This should provide further downside pressure on Nvidia's pricing power.
Regulators are doing Nvidia no favors, either. On two separate occasions, U.S. regulators have imposed restrictions on AI-GPU exports to China. This is a potentially big blow to Nvidia, which regularly generates between 20% and 25% of its sales from the world's No. 2 global economy by gross domestic product.
Lastly, history could be Nvidia's worst enemy in the new year. There hasn't been a next-big-thing investment trend over the past 30 years that's avoided an initial bubble-bursting event. This is to say that investors have a tendency to overestimate the adoption/uptake of new innovations without giving them the proper time to mature. Artificial intelligence is unlikely to be the exception to the rule, which could sink Nvidia's proverbial ship in 2024.
