Big Tech Stocks Have Never Looked Cheaper. Is the Magnificent Seven a Screaming Buy?
Following another sell-off in tech stocks, the Nasdaq Composite(NASDAQINDEX:^IXIC) is now on the verge of a correction as the index is down roughly 8% from its closing peak.
On Friday, the trigger was underwhelming earnings reports from a slew of tech companies like Amazon, Intel, and Sandisk, offering the latest evidence that investors have grown weary with the AI trade .
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Amazon joined its hyperscaler peers like Alphabet, Microsoft, and Meta Platformsin falling in response to earnings, a sign that investors have become skeptical of the massive capital spending taking place in the cloud computing industry. Combined, these four companies are set to spend more than $700 billion this year. The world has never seen an infrastructure build-out of that size.
Though these stocks have all fallen this earnings season, their profits continue to grow, meaning many of them are as cheap as they've ever been. All four hyperscalers are reporting record profits, and, except for Microsoft, they're all trading at substantial discounts from their recent peaks.
How cheap are the hyperscalers?
Assessing the valuation of these stocks isn't so easy. With the exception of Microsoft, they don't adjust their earnings to reflect one-time events, so reported earnings per share doesn't offer a clear picture of profits. Alphabet and Amazon, for example, both made large gains in their investments in Anthropic this year.
If we use operating income instead, we can get a better sense of their valuations.
AMZN EBIT (TTM) data by YCharts
Combined, these companies had roughly $490 billion in operating income in the last year, including Amazon's most recent quarter. Their total market cap is now $11.5 trillion, meaning they trade altogether at 23.5 times operating income, which is similar to the S&P 500.
Image source: Getty Images.
Why are big tech stocks so cheap?
The simple explanation for why these stocks have gotten so cheap is that all four of these, except Microsoft, are now burning cash to fund their AI build-outs, and investors have gotten spooked by the risk in that investment.
AMZN Free Cash Flow (Quarterly) data by YCharts
Updated for the third quarter, Amazon's free cash flow dropped to a loss of $34.8 billion.
Even though three out of four of these stocks have large, highly profitable cloud computing businesses that can monetize that spend, the AI industry is still new, and long-term demand is uncertain.
Is it time to buy the hyperscaler stocks?
All four of these companies are growing revenue well into the double digits, as the chart below shows.
AMZN Free Cash Flow (Quarterly) data by YCharts
They have continued to defy the law of large numbers and are delivering growth rates rarely seen for the biggest companies on the market, which are typically mature businesses.
Those growth rates should also assuage concerns about their ability to earn a return on their capital investments, especially as Amazon, Microsoft, and Alphabet have all seen growth dramatically accelerate in their cloud divisions.
Meta does not currently have a cloud business, but the company could launch one, as CEO Mark Zuckerberg has openly discussed it. In addition to its rapidly growing advertising business, Meta has promising growth businesses in smart glasses and Muse, its new personal AI agent, and it likely has more in the pipeline.
Overall, these stocks are making record profits and are well-positioned to lead the AI boom, which is why they're investing heavily in it. For them to trade at a similar multiple to the S&P 500when they're growing much faster than the index and with larger profit margins is a mistake. Investors should take advantage of the double-digit discount in these stocks and scoop them up while they're cheap.
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Jeremy Bowman has positions in Amazon and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Amazon, Intel, Meta Platforms, and Microsoft. The Motley Fool has a disclosure policy .
Big Tech Stocks Have Never Looked Cheaper. Is the Magnificent Seven a Screaming Buy? was originally published by The Motley Fool
