Shares of 6 mega-cap companies that run the economy should dominate the stock market

Published Thu, Jul 11 20246:23 AM EDT

We hear the warnings all the time. The market is only driven by a handful of massive tech stocks – and therefore, it's built on a weaker foundation than a market advancing on a broader swath of its constituents. We think that view is lazy and misguided. In his Sunday column , Jim Cramer told Investing Club members that they should quit worrying about the triumph of tech and learn to love it. Jim wrote that investors should stop thinking, "This can't possibly last," and instead think, "Not only could it last but look for others to join in." That's because the halo of the artificial intelligence boom has started and will continue to benefit companies beyond technology. But it's early days for Club industrials such as Eaton and Dover to get boosts from the retooling and building of data centers to handle AI workloads. Great companies are too great? In the meantime, what are we supposed to do? Tell investors to avoid the S & P 500 because the great companies found in the index are simply too great. Do the so-called market experts saying that not hear how ridiculous that sounds? Would it be better if we have a 500-stock index of 500 average stocks? Where do you think the S & P 500 would be today if not for the Super Six mega-cap tech names that we own in the Club portfolio? Does anyone think we would be better off if those stocks didn't outperform? This whole narrative reminds me of something we heard more than a few times back in 2022 when the market was selling off as a result of multi-decade high inflation and the Federal Reserve's interest rate hikes to combat it. I kept hearing money managers and strategists come on CNBC, saying companies that led the last bull market won't lead the new one. That annoyed me to no end. Not because it wasn't true. It may well be true that historically the old leaders don't lead again. No, it was that such a view in no way spoke to the businesses of these companies or their underlying fundamentals. What does the end of a bull market on the back of inflation and Fed rate hikes have to do with the earnings potential over the next several years? That's what matters for the likes of those Super Six stocks: Amazon , Apple , Microsoft , Meta Platforms , Nvidia , or Alphabet . The proof is the rallies in these stocks last year and so far in 2024 against moderating inflation and a Fed getting ready to cut rates. Analysts at Barclays said Wednesday that "consensus estimates imply that Big Tech earnings growth will continue to dominate in 2Q24 [second quarter 2024], with nearly +32% EPS expansion expected vs. the rest of the SPX at +3.3%." Wow, that's a big difference and further evidence that it's nonsense for long-term investors to be more concerned about coincidental market happenings rather than fundamentals. Companies don't lose dominance or stock leadership because they were dominant the last time we had a bull market. They fall behind because they get disrupted and/or fail to innovate and adapt to the desires of their customers. Did IBM fall from grace because it was once the most valuable stock in the world? Or was it because the company didn't keep up with the latest data center and cloud computing innovations? It's the same thing we're seeing now, calls on the market based on the price action of the stocks, rather than how the businesses those stocks represent are doing. Nvidia is up over 1,000% since October 2022 —so what? It's still valued at about 40 times forward earnings, right in line with its five-year average. We can't fault investors for taking some profits from time to time. We trimmed Nvidia, Meta Platforms, Palo Alto Networks , and five other tech stocks at the beginning of the year. On Monday, we trimmed Meta and Palo Alto again. I say trimmed because these sales in no way changed our views of these great companies. We didn't light up on these incredible businesses because they've done great. Avoiding a market because the best of the best are getting better is ridiculous. To be clear, we have seen concentrated markets before — and guess what, they don't always end in catastrophe. That's not to say it can't or won't happen, only that we are again seeing extreme concentration, which is not in and of itself a reason to avoid the market, especially for those investing in individual companies. Concentration vs. diversification Some people will argue that the concentration in these names is bad for diversification. However, within the Super Six, we have three S & P 500 sectors represented: Apple, Microsoft, and Nvidia are in technology; Amazon is in consumer in discretionary; and Meta and Alphabet are in communications services. These companies also have a slew of businesses inside of them, serving many end markets. Within Amazon, we have a video subscription business, online shopping, cloud computing, delivery and logistics that rivals the likes of United Parcel Service , advertising, home security with Ring and Blink, groceries, and several other services like books, music, and so on. Within Microsoft, we have cloud computing, consumer electronics, enterprise software, gaming, search, and more. Within Google-parent Alphabet, we have cloud computing, YouTube video streaming, search, shopping, travel, navigation, and countless other potential businesses in development like Waymo self-driving cars. Within Apple, we have consumer electronics expected to do nearly $300 billion in sales this fiscal year and a services business expected to do nearly $100 billion. If Apple's services were its own company, it would rank in the top 50 of the S & P 500 by revenue. Meta is a bit more of a pure play on social media with Facebook and Instagram, but we've also got a growing hardware business in reality labs, and a serious player in generative AI, thanks to the development of Llama 3. Nvidia, which is heavily driven by data center revenue, has a rapidly growing suite of software offerings and is critical to all things technology-related now that we're reaching the end of the central processing unit's (CPU) ability to realize rapid gains in computing power year after year. That's why Nvidia's graphics processing units (GPU) are in such hot demand. While we're talking about only six stocks, there are a whole heck of a lot more than six businesses driving the gains in their stocks. Would the market suddenly become more investible if we broke up the Super Six into say 15 different companies and stocks? They would be the same businesses — arguably a bit less effective because we would be disrupting their ability to aggregate, analyze, and leverage data – but hey, at least they would be more than six stocks. Should that make us feel better? In a commentary on Monday , we looked at a sum-of-the-parts (SOTP) analysis on Amazon and concluded the company has the potential to grow more in the long term with the business units together rather than separately. Market reflects economy It's not a stretch to argue that what we're seeing in the market is, in many ways, reflective of the U.S. economy. If you have ever been at work during outages of Google's Gmail or the Amazon Web Services cloud, you know just how critical the infrastructure developed by these companies is to worker productivity. Every business in the world wants to increase efficiencies – and as it looks now, the cloud computing, generative AI, and automation that these companies offer their mega-caps offer are going to be the fastest ways of doing that over the next decade. Yes, these companies make up a massive share of the S & P 500. But guess what? They also generate a massive share of the indexes' earnings power. Put another way, the market dominance of this handful of stocks shouldn't be a cause for concern because when you think about it, fundamentally, it makes perfect sense. They are mission-critical for enterprises, and they are increasingly leveraged by consumers because they know what we want before we do, a dynamic that will only strengthen as generative AI is further integrated into all these platforms. Valuations stretched Have the valuations of these companies gotten a bit out of whack? In some cases, maybe a little bit, as noted by Jim in his Sunday column. Apple is trading at 32 times forward earnings versus a 25-times five-year average. Microsoft is trading at 35 times forward earnings versus a 29-time five-year average. For comparison, the S & P 500's three-year average multiple is roughly 21.5 times forward earnings. If you're a long-term investor, then these steep tech valuations serve as a reminder to maybe book profits on the way up. However, we don't think they are a reason to bail entirely on any of these names. For starters, the market is forward-looking — and as we see it, we're entering a new age for all of them. They are running leaner than ever following the forced review of costs as the Fed hiked rates in 2022. But they still have plenty of avenues for further revenue growth and increased operating leverage. So, we think the "overvaluation" we see in some of these names stands to be corrected via earnings growth in the years ahead. For example, Microsoft's valuation falls to about 32 times on calendar year 2025 numbers, while Apple's valuation comes out to about 31 times on 2025 estimates. The likelihood of lower rates in the future can also be viewed as supportive of elevated multiples. Let's not forget that the balance sheets of these companies rival those of nation-states. In other words, a premium is warranted for all of these names given their dominance, mission-critical nature, and financial strength. All of this allows them to not only survive in a higher-rate environment or economic downturn but actually capitalize on it by investing in the future while smaller competitors fight to stay afloat. Bottom line How much of a premium is warranted? That's what makes a market. At current levels, we don't think the valuations we're seeing in Big Tech put us at risk of some crash in the stocks. Instead, there is more risk in trying to hop in and out of these names than riding out the volatility with the understanding that over time, earnings growth will bring down the valuations and power the stocks to further upside in the years to come. If you don't own shares in the Super Six and want to get in, we calculated some levels to buy. If you are invested in them and are considering taking profits, here are three questions we would ask. But remember to focus on corporate fundamentals and don't let headline nonsense like "the old leaders can't lead again" or "the market is being propped up by a few companies and should therefore be avoided altogether" scare you out of putting money to work. (See here for a full list of the stocks in Jim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

The New York Stock Exchange stands in lower Manhattan after global stocks fell as concerns mount that rising inflation will prompt central banks to tighten monetary policy on May 11, 2021 in New York City. By mid afternoon the tech-heavy Nasdaq Composite had lost 0.6% after falling 2.2% at its session low.

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