Over three days in late July, America's tech giants put on an impressive show. Apple, Microsoft, Alphabet, Amazon.com, and Facebook had thrived, and their latest earnings reports hammered home the point. The five companies generated a combined $332 billion in revenue from April to June, up 36% from a year earlier. All of their profits were better than expected. The twist is that all of their stocks, save for Alphabet's, sold off on the news.
The negative reaction reflects the paradox surrounding America's Big Tech complex. Their products are being used more than ever, just as the companies have become increasingly disliked. Regulators and lawmakers -- cheered on by a bipartisan mix of constituents -- are scrutinizing each business and threatening significant actions to curtail their power. Evercore ISI analyst Mark Mahaney estimates that the regulatory scrutiny has already created a 10% drag on large tech stocks.
After thriving, tech companies are facing the challenges posed by a rebounding economy, as businesses and consumers potentially return to old, more analog habits.
Big Tech has hit a perilous moment. It won't last. The five megacaps still have the best business models on the planet, and their stocks look relatively cheap. Investors should own them all, even if the regulatory headwinds take a while to abate.
Taken together, the five tech giants -- the largest companies in the U.S. stock market by a wide margin -- offer a way to invest in the global economy's most important trends: digital transformation and cloud computing, and the future of communication, entertainment, commerce, and work.
The cloud alone could power the growth of Microsoft $Microsoft(MSFT)$, Amazon$Amazon.com(AMZN)$, and Alphabet$Alphabet(GOOGL)$ from here.
"Cloud is the reason I own all three of them," says Walter Price, who runs the tech investment team at mutual fund company Allianz Global Investors. "The world's enterprises are shifting computing to the cloud. This will be an annuity that lasts for decades. They can sell so many more things to their customers over time."
Price, who has been running money at Allianz for close to five decades, sees a precedent in IBM $IBM(IBM)$, which came to dominate tech spending in the era of mainframe computing.
The old saying was that you don't get fired for buying IBM. Now, the saying applies to Microsoft, Price says. IBM's recipe was selling more software and more services to more customers. Each of the Big Tech companies are following the same playbook.
There are near-term challenges, to be sure. A hangover looks the most obvious at Amazon, where e-commerce is growing more slowly than in the past. Apple's $Apple(AAPL)$ hardware boom has slowed. And all of Big Tech's hardware arms are feeling the effects of component shortages and skyrocketing shipping costs. Apple has said that iPhone production could be crimped by parts shortages.
Another worry: Big Tech's dominance has some investors seeing a peak in valuations. Apple, which leads the pack with a $2.4 trillion market value; Microsoft ($2.2 trillion); Alphabet ($1.8 trillion); Amazon ($1.6 trillion); and Facebook ($1 trillion) now accounts for 23.3% of the S&P 500 index's value.
Then again, skeptics have spent years waiting for the law of large numbers to kick in. At the end of 2019, the Big Tech companies were about 18% of the S&P 500. Since then, each of the stocks has gained at least 70%.
Big Tech is eating the stock market, but technology is doing the same to the rest of the world -- and the five megacaps remain the best way to play the trend.
Nonetheless, the regulatory overhang is real, even if there are signs that the risks have been priced in. That was one takeaway from a relief rally of 4% in Facebook (FB) stock in June after an antitrust lawsuit from the Federal Trade Commission was thrown out by a federal judge.
Tech regulation is gaining steam in Washington, but the courts could hold back the most aggressive efforts. And some investors think that the worst-case scenario -- forced breakups -- could actually unlock value to the benefit of shareholders.
The long-term business trends offset the regulatory risks. Speedy 5G mobile networks are still rolling out, for instance, which will drive strong smartphone sales and more usage of social networks and cloud-based applications.
And then there are the wild cards, which investors haven't even begun to price in. All of Big Tech is poised to benefit if Facebook CEO Mark Zuckerberg's vision of a mixed reality "metaverse" comes to fruition. He sees people working, socializing, and transacting all within an even more expansive internet.
Apple is weighing an entry into the automobile market, while Alphabet could dominate the future of autonomous cars through its Waymo unit. Amazon and Apple are both taking a stab at healthcare and fitness. Facebook hasn't even tried making money off WhatsApp, its global messaging platform with about two billion users.
The investment upside applies across Big Tech, but each company has different opportunities and challenges.
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