Key Takeaways

• Strong performance of the “Magnificent 7” 1(Mag 7)has led many U.S. market indexes to beconcentrated in a small number of highly valuedcompanies.
• We find that these companies are more diversifiedthan you may think. However, they are expensive,and they may struggle to meet lofty expectations.
• We don’t think investors need to avoid the Mag 7,but it may be prudent to augment Mag 7 exposurewith non-U.S. markets which offer geographic andsector diversification.

The “Magnificent Seven”

The “Magnificent Seven” (Mag 7) refers to seven leading U.S. companies associated with big technology trends like artificial intelligence, cloud computing, and high-performance computer chips. These companies comprise almost 30% of the S&P 500. Compared to the past, this is a very high concentration in a small number of companies. Their high concentration, along with their high valuations, have led some investors to eschew equity markets.

We find that the Mag 7 are not as concentrated as some might think, and they may be worth their high valuations. However, investors should be cautious about having too much exposure to the Mag 7 because investing in companies with extremely high expectations can be risky. Instead of avoiding the Mag 7, we suggest diversifying to non-U.S. equity markets, which offer geographic and sector diversification.

The “Magnificent 24”?

The best companies evolve over time. For example, in 2000, Apple was basically a computer company (it changed its name from Apple Computers to Apple Inc. in 2007). Today, Apple Inc. has at least five distinct and highly successful business lines – iPhones, wearables, Macs (computers), iPads, and software services. Many of today’s big technology companies have similarly diversified their product lines. If you look at the underlying businesses within the Mag 7, you see that there are actually 24 distinct business lines with annual revenues above the median company in the S&P 500 ($13B).

Clearly, many of those business lines are related to technology, but some are related to other industries, like retail (Amazon) or autos (Tesla). In certain cases, these business lines can complement each other to create an “ecosystem” that encourages more and more product adoption. This has created a “winner-take-all” phenomenon with several big technology companies, where the success of one business line has ed to the success of other business lines.

High Valuations

This success has helped the Mag 7 trade at very high price/earnings ratios (28 times next year’s estimated earnings) compared to the rest of the market (the remaining 493 securities in the S&P 500 trade at a price/earnings ratio of 19 times). But the Mag 7 are also growing much faster than the other 493 companies in the S&P 500. Mag 7 companies grew their earnings by 43% over the last year, compared to only 7% for the rest of the S&P 500. Further, analysts expect that Mag 7 companies will continue to grow by over 25% over the next year. Is this additional growth worth the higher price? It depends on whether they can deliver on exceptionally high expectations.\

A Cautionary Tale

In March 2000, Cisco Systems was dubbed the “backbone” of a revolutionary new technology (sound familiar?)—the Internet. At the time, they were trading at an astronomical price/earnings ratio of 325 times. Since then, they have tripled their revenue and grown their earnings per share by an impressive 1,800%, but their stock price has declined by 33% since 2000.

Great companies can produce exceptionally good financial results (earnings growth, etc.), but their investment results (share price appreciation) may be very different if they are not able to meet the lofty expectations incorporated into their prices.

7 or 24, Still Mostly Tech

Whether you think of the Mag 7 as seven large technology companies or 24 technology-related businesses, the dominant industry exposure is still technology. The 24 different business lines within the Mag 7 offer some diversification of product lines (most small- and mid-sized companies rely on one product), but most of the underlying business are still related to technology.

As U.S. technology companies have grown, U.S. equity markets have gotten progressively tilted towards technology. For example, 39% of the S&P 500 is now composed of technology2 companies. In contrast, developed non-U.S. equity3 markets have much less exposure to technology (only about 13%) and more exposure to traditionally cyclical sectors like industrials (17%), financials (19%), and consumer discretionary (12%). Additionally, non-U.S. markets are also quite a bit cheaper on a price/earnings basis.

In our view, investors should not necessarily avoid the Mag 7 – these are some of the best-positioned companies in the world – but this may be a good time to diversify into non-U.S. markets.

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1. The Magnificent 7 are: Alphabet (Google), Meta (Facebook), Amazon, Tesla , Apple, Microsoft, and Nv idia.
2. Includes both Communication Services and Information Technology Technology.
3. Sector exposures are for MSCI EAFE, as of 4/11/24.

IMPORTANT INFORMATION

Centrus Financial Strategies

Financial planning and investment advisory services offered through Prosperity Capital Advisors (PCA), an SEC registered investment advisor. For more information, please visit www.adviserinfo.sec.gov.

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This is for informational purposes only, is not a solicitation, and should not be considered investment, legal or tax advice. The information in this report has been drawn from sources believed to be reliable, but its accuracy is not guaranteed, and is subject to change. Investors seeking more information should contact their financial advisor.
Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss. Actual client results will vary based on investment selection, timing, market conditions, and tax situation.
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C24-20799 | 01/2024 | EXP 01/31/2026