It’s been a rough year for the stock market, but even more so for megacap tech stocks. From early 2022 through early August, the four largest technology companies lost an average of 14% in value including dividends, compared with a 12% decline for the S&P 500 index. (Prices, returns and other information are as of August 5 unless otherwise noted.)
As measured by market capitalization (times the largest value), the top four tech companies are the largest U.S. companies of any kind. In order of size, there are four Mega Apple (APL) Microsoft (MSFT), Alphabet (GOOGL) and Amazon.com (AMZN) shares have more than tripled in value over the past five years, each with a market capitalization of more than $1 trillion. But investors are misled by what behavioral economists call “recentness bias,” or paying so much attention to current events that losses in the past few months become prominent in investment decisions.
Smart investors take the long view, both forward and backward. They carefully look at the growth of a company over the years and then try to predict a ten-year period. In this type of analysis, the 2022 crash is clearly a buying opportunity for three reasons:
adaptation. Each Mega Four started with a big idea: search-based advertising for Google, personal computing for Apple, online shopping for Amazon and Microsoft’s operating system. No one left their original job, but all moved on to other fields. Those transitions were dramatic and almost unique among corporations. The flexibility shown by the Mega Four is good for adapting to changing markets in the future.
For example, each of the four is a leader in the highly profitable cloud computing business, which allows users to store large amounts of data remotely and securely, accessible from anywhere in the world. Three-quarters of Amazon’s profits last year came from its cloud-computing unit. In the quarter ending June 30, Microsoft Intelligent Cloud revenue represented 39% of the company’s total sales. Alphabet’s cloud revenues rose 35% in the same quarter.
Even Apple, a manufacturing company, recognizes the value of cloud computing. In addition to the cloud, revenue from the company’s services division, which includes Apple TV+, Apple Music, Apple Card and the App Store, is growing three times faster than iPhone sales. Forbes predicts that profits from services will reach $50 billion by 2025.
All companies are using a subscription model to ensure cash flow, the best example being Amazon Prime. In addition, Apple and Amazon have invested heavily in video production and streaming.
Alphabet’s YouTube, despite being blocked in China, has become a huge global advertising vehicle with 2.6 billion users. Meanwhile, Microsoft is one of the three largest gaming companies in the world. Alphabet’s Google owns Nest Thermostats and VirtualLife Sciences. Amazon owns the Whole Foods chain with $17 billion in revenue. Alphabet’s Gmail service accounted for 37 percent of all email openings last year, making it the world’s largest.
Not all of the tech companies’ investments (or “other bets,” as Alphabet officially calls them) have paid off — Google Fiber, which has brought superfast Internet connections to nearly a dozen cities, has been disappointing for one. The Mega Four have impressive acquisition records and a lot of money to buy many businesses. Between the three, Microsoft, Apple and Alphabet have a combined total of nearly $300 billion in cash and short-term investments on their balance sheets.
Congress and regulators may actually get in the way and block further growth. But big tech companies like Amazon Web Services, the largest cloud services company in the world, have grown into their own companies.
Profitability. The reason the Mega Four have so much cash is because they are profitable. Return on equity is net income divided by stockholders’ equity (the net worth of the firm, or what a company would be able to give to shareholders if liquidated). According to the Nasdaq primer, return on equity “allows investors to identify companies that are actively deploying cash to generate high returns.” Apple’s current return on equity is 153%. In other words, raising $1 million in equity yields $1.53 million in profit! For comparison, the average in the small computer sector is 19 percent, according to investment research firm Zacks.
A measure of gross profit is operating margin or return on sales—that is, profit divided by revenues. The average figure for all US industries is 11%, but Microsoft’s is nearly 40% over the past 12 months, and Alphabet’s is about 30%. Amazon is primarily a retailer, so its margins are low, but its cloud business has an operating margin of around 30%. No need to get bogged down in statistics. Suffice it to say, these companies are profit machines, even as the economy seems to be tanking as the Federal Reserve raises interest rates to curb inflation.
Price. Now I come to the best part of the Mega Four story: these stocks are cheap. I can’t predict whether they’ll be worth it in the short term, but being a partner in some of the world’s best businesses is clearly a better deal today than it was at the beginning of the year.
Alphabet, whose shares fell from $148 to $117 earlier this year, now carries a price-to-earnings (P/E) ratio based on analysts’ consensus forecasts for the next 12 months, 22 and Apple’s earnings. He is 27 years old. Despite a recent rally, Amazon is much lower than it was two years ago, and Microsoft has lost $59 since trading at $342 in November 2021.
It was the fifth largest company in the United States and now ranks 11th. Meta forums ( META ), the former Facebook, offers a striking contrast to the Mega Four. About 97% of Meta’s total revenue comes from ad sales, which declined in the last quarter due to exposure to general global economic trends and increased competition. Meta is trying to make a change of its own, “moving beyond 2D screens to immersive experiences like augmented and virtual reality to help us build the next evolution in social technology,” according to its latest earnings report.
Can meta-governance manage such a massive, risky transition? That’s not certain, but when it comes to reviews, it’s hard to argue against Meta. The stock is down 50% this year, and the P/E is currently just 18. Meta and Johnson & Johnson ( JNJ ) have the same market cap, but Meta gained 40% more in the most recent quarter.
Of all the ideas that spawned America’s biggest tech companies, Facebook was the simplest and most revolutionary. It has completely changed the way we interact with other people and has elevated the world of advertising. Today, one in six ad dollars in the world is spent on Facebook – twice as much as on Google.
For the Mega Four – or Five – the main issue is their success. I understand that the market battlefield is full of giant winners who are losers, General Electric (GE) being a prime example. There are no guarantees in investment. But when the market turns sour on companies because of the economy, it’s a good time to buy the best.
James K. Glassman chairs Glassman Advisory, a public affairs consulting firm. He does not write about his customers. Of the stocks mentioned here, they own Microsoft and Amazon.com. It is his latest book. Safety Net: A strategy to de-risk your investments in turbulent times. You can reach him at James_Glassman@kiplinger.com.
