Magnificent 7 earnings on deck, what you need to know

Posted by David Nelson, CFA on July 24, 2023 in Investment Management | Leave a comment

By David Nelson, CFA
 
I get it. I look like I just came in from off the street. It’s Sunday morning, the crew is out, and I have to bang out this report before I can get some sleep.
 
The next two weeks will go a long way in shaping investor sentiment for the remaining dog days of summer. On deck this week, three of the Magnificent Seven stocks are set to report.

Bloomberg Data

Alphabet (GOOGL), Microsoft (MSFT) and Meta (META) report Tuesday and Wednesday respectively, with Apple (AAPL) following up next week. If Tesla (TSLA) is any indication, investors will want to see some food on their plate justifying the monster returns they’ve seen this year.

Let’s dig into it. Welcome to the Money Runner. I’m David Nelson.

Traders will look to lock in gains, hedge funds will lean short and long term investors will be biting their nails, glued to their favorite market show or smartphone app.

If you’re holding on to these stocks because you’re looking for a big A.I. bump right now, then you need to sell the minute you read this post or watch my podcast.

A.I. and the productivity benefits that come with it are a long-term story that will take years to play out. It’s true that stocks have and will start to discount the thesis long in advance, but the real monetary benefits are in the out years.

I still stand by my call that the bigger beneficiaries to artificial intelligence will be the hundreds of Fortune 500 companies that use the technology to enhance the top and bottom line. Go to my podcast from last week, So you missed the bull market for a list of companies that are already using the technology and getting results, right now.

The advertising concerns are real

Bloomberg Data

Just about every line item for Omnicom (OMC) and Interpublic Group (IPG) were less than expected., Both pointed to advertising softness in tech and telecom verticals. Intuitively, that makes sense, as we’ve seen a major push by technology companies to shore up spending and focus more on the bottom line.

Bloomberg Data

Most of the street looking for upside this quarter have published that they see an increased focus on earnings and cash flow. Last year, Alphabet delivered just over $60 billion in free cash flow. Consensus this year is for 14% growth, but some of the bulls on the street, like Goldman’s Eric Sheridan, believe they could hit $77 billion in free cash flow for 2023. That’s 31% growth.

GOOGL FCF

Bloomberg Data

Revenue isn’t growing at that pace, so it has to be coming from better margins and expense controls. Past technology models that focused only on revenue growth don’t hold water following a 2021 bust. That holds true for venture capital as well.

I’ll be looking for commentary on the call about a softening ad dynamic offset by increased efforts to drive the bottom line. I also expect commentary on A.I. with a focus on the integration of large language models (LLM) into search. I do not expect that to be a meaningful input to profitability just yet.

Is Microsoft a monopoly?

Of course, it is. Microsoft (MSFT) slowly devours its competition. Step by step they copy and bundle new services into their offering. Just a couple of weeks ago, half a dozen cybersecurity companies, including Palo Alto Networks (PANW), CrowdStrike (CRWD) and Zscaler (ZS), were down hard on news that Microsoft was making an entry into cybersecurity with little in the way of details.

How often have we seen Microsoft sidestep regulatory scrutiny over predatory behavior? The company should be broken up, but that’s just me. In the meantime, it’s hard not to own the second largest company in U.S. markets with such a clear advantage. You pay a premium for that. At 35 times this year’s and 31 times next year’s earnings, it’s a big premium.

Mark Zuckerberg and Meta (META)

It’s pretty clear Mark got the memo last year when he did a 180-degree reversal, scaling back the pace at which he was rolling out the metaverse. It took a 77% fall in the stock and likely his net worth to get that message, but he got it. Reversing course, he put an increased focus on profitability, laying off as many as 20,000 employees since last November.

The cautionary results and commentary out of (OMC) and (IPG) apply here as well. I think Reels will get an outsized focus given the popularity of short form video. All of us doing podcasts or any video content have come to realize the importance of short form. The attention span of the average American watching video is probably about 7 seconds. You can bet advertisers understand that all too well.
 
If Mark can get the same kind of traction in Reels as he has in other parts of the platform, success won’t be measured by a single quarter’s hit or miss. On a path to double digit revenue growth, trading at an undemanding 18x next year’s earnings, it’s not surprising most analysts choose this stock as their favorite of the Mag 7 heading into the prints. The stock is up 149% year to date, so you can bet I’ll be biting my nails on this one too.

Bloomberg Data

With a combined market cap of $4.8 trillion, all three face challenges going into the reports. Alphabet seems to have the lowest bar to jump over, but investors are sitting on a lot of gains. Down 6 to 7% in any of them will trigger even more selling as traders lock in whatever profits are left.

The smart money will be sitting below ready to buy those shares.

*At the time of this post some funds managed by David were long GOOGL, MSFT, META, AAPL, TSLA and PANW.