Big Tech Stocks Experience Slowdown Ahead of Earnings Reports

The slowing growth of profits is diminishing the aura of invincibility that has long surrounded the major technology companies. As these giants prepare to announce their earnings this week, investors are eager to see if they can reverse this trend. The performance of these stocks will significantly influence the ongoing rally in the stock market.

The five largest companies in the S&P 500 Index—Apple Inc., Nvidia Corp., Microsoft Corp., Alphabet Inc., and Amazon.com Inc.—are projected to report an average earnings growth of 19% for their third-quarter results. Although this figure significantly exceeds the anticipated 4.3% increase for the S&P 500 as a whole, it marks the slowest collective earnings expansion for these tech giants in six quarters, according to data from Bloomberg Intelligence.

Furthermore, the earnings growth gap between Big Tech and other market sectors is expected to continue narrowing into 2025, moving further away from last year’s approximate 35% quarterly earnings growth. This raises critical questions for investors about the future of these stocks, which have significantly risen during the market rally, and whether they can maintain their leadership in pushing indexes higher.

“Sentiment is more uncertain than in previous quarters, and the factors influencing the market are more negative,” remarked Andrew Choi, portfolio manager at Parnassus Investments. “This doesn’t necessarily mean the rally is over, but there are certainly opportunities elsewhere, especially with ongoing debates regarding Big Tech valuations, slower earnings momentum, and controversies that affect sentiment.”

Changing Market Dynamics

For most of the last two years, technology giants propelled the S&P 500 higher, driven by steadily increasing profits and investors eagerly paying higher multiples for those earnings. However, this trend has shifted in recent months.

Since reaching a peak on July 10 after a remarkable 22% rally at the beginning of the year, the Bloomberg Magnificent 7 Index—which includes the five leading S&P companies along with Meta Platforms Inc. and Tesla Inc.—has decreased by 2%. This decline stands in contrast to notable gains in other major sectors, such as utilities, real estate, financials, and industrials, all increasing over 10%, whereas the broader index has only gained 3.1% in the same time frame.

This new dynamic places Big Tech companies in an unfamiliar spot as they transition from market leaders to underdogs. They are now under more scrutiny, dealing with higher valuations and questions regarding the return on their substantial investments in artificial intelligence (AI).

“The change in technology's leadership role could last until the end of the year, but it does not deter us from viewing these companies positively in the long term,” noted Ross Mayfield, investment strategist at Baird. “There is certainly a risk associated with the deceleration of earnings growth and potentially stretched valuations. However, these companies still promise substantial growth and have significant upside potential in earnings over the coming years.”

While Tesla has already reported higher-than-expected profits for the third quarter and optimistic future projections, the major financial reporting for Big Tech kicks off significantly this week. On Tuesday, Alphabet Inc. is set to release its financial results, followed by reports from Microsoft and Meta Platforms on Wednesday, and concluding with Apple and Amazon on Thursday. Nvidia is not expected to announce its results until late November.

The Future Focused on AI

Each company reporting this week faces its own set of challenges. Microsoft deals with uncertainty about its AI prospects; Apple has noted early signs of weak demand for its newest iPhones, although longer-term optimism has driven its stock to record levels; Amazon investors are concerned about the impact of heavy capital spending on profits; and Alphabet is under regulatory scrutiny from the US Justice Department regarding alleged monopoly practices.

AI-related investments will be a focal point for investors during this earnings season, especially regarding the significant expenditures on infrastructure by the companies. In the third quarter, Microsoft, Alphabet, Amazon, and Meta Platforms are projected to have invested approximately $56 billion into capital expenditures, representing a 52% increase from the same period last year.

Investors mostly accept that such investments in AI are crucial for the future of technology. However, there is limited evidence indicating immediate profitability from AI integration, particularly for Microsoft, which has included AI features into its software. Disappointment amid past earnings seasons over the imbalance between AI-related spending and expected outcomes has raised concerns about profitability margins moving forward.

“Income growth is increasingly being offset by rising AI-related capital expenses,” stated Bloomberg Intelligence strategists Gina Martin Adams and Michael Casper. “This suggests that peak margins may now be in the rearview mirror, at least for the short term.”

The recent underperformance of Big Tech aligns with deteriorating sentiment among prominent Wall Street investors. Hedge funds have been offloading Magnificent Seven stocks for several months; despite some modest buying in October, the net long positions as a percentage of total US exposure are at their lowest since mid-2023, according to Goldman Sachs data.

Valuation Challenges Ahead

Despite declines in stock prices among these mega-cap companies, many continue to maintain valuations that are above historic averages. For instance, Apple is trading at 32 times its projected profits for the next 12 months, compared to a 20 times average over the past decade. Microsoft is priced at 33 times its estimated future profits, well above its 25 times average.

“When analyzing tech investments, one must consider whether earnings will grow sufficiently to align with these multiples, or if recent performance is simply driven by a fear of missing out,” noted Clark Bellin, chief investment officer at Bellwether Wealth. “While momentum is a factor, there might come a point when the market dynamics shift, necessitating a more cautious outlook during this earnings season.”

Nonetheless, many professionals on Wall Street remain notably optimistic about Big Tech. Approximately 90% of analysts covering Microsoft, Alphabet, and Nvidia hold buy ratings for these stocks, alongside 83% for Alphabet and 65% for Apple, whereas the overall buy rating for the average S&P 500 company stands at roughly 53%.

The underlying reason for this optimism is straightforward. In spite of current concerns, Big Tech companies continue to offer above-average profit growth, exposure to AI technologies, solid capital returns, and comparatively lower risk than other market sectors, according to Andrew Choi at Parnassus.

“It’s challenging to find market leaders that provide this level of earnings growth,” he remarked. “There is still much to be positive about.”

Tech, Investors, Earnings, Growth, AI