By Key Points
The “Magnificent Seven” stocks are well positioned for artificial intelligence, which is a long-term growth opportunity.
Net income for some of these stocks has been inflated by profitable investments, but their operating incomes are still rising.
These companies are still producing higher sales growth rates than the S&P 500 as a whole.
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The “Magnificent Seven” stocks have captured a lot of headlines over the years, but they haven’t been as impressive recently. The Roundhill Magnificent Seven ETF (NYSEMKT: MAGS), a fund that exclusively tracks them, is only up by 5% year to date.
It’s trailing the S&P 500 and Nasdaq Composite this year. There are a few key details investors should consider when assessing whether the underperformance is temporary or part of a long-term trend.
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Tesla is dragging down the Magnificent Seven
Most of the Magnificent Seven stocks are still up year to date. The low returns from the Roundhill Magnificent Seven ETF are largely due to Tesla‘s (NASDAQ: TSLA) poor performance. The electric vehicle maker’s stock is down by more than 20% year to date.
The company’s profit margins continue to narrow despite rising revenue. One big concern is that Tesla is losing ground to Waymo in the autonomous vehicle race, a critical piece of Tesla’s lofty valuation.
Meta Platforms (NASDAQ: META) has also endured a tough stretch despite posting rising revenue. A legal battle has forced the company to limit teens to two hours per day on Facebook and Instagram, cumulatively, time that can be extended with a parent’s permission. It’s big news for child safety advocates, but it’s unlikely to make a big impact on Meta Platforms’ financial results.
Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), Amazon (NASDAQ: AMZN), and Microsoft (NASDAQ: MSFT) continue to do well in multiple industries, with their respective cloud computing platforms accelerating rapidly due to artificial intelligence (AI). Accelerated iPhone demand has been helping Apple (NASDAQ: AAPL) outperform the S&P 500, and Nvidia (NASDAQ: NVDA) continues to crush Wall Street forecasts.
Valuations aren’t as good as they appear
Most of the Magnificent Seven stocks are still gaining market share and posting respectable growth rates. In fact, all of them posted higher revenue growth rates in the second quarter than the blended revenue growth rate for the S&P 500.
That has resulted in some attractive price-to-earnngs (P/E) ratios. For instance, Alphabet trades at a P/E or 17 and Amazon at 21.
These valuations are good for the type of net income growth those companies are achieving, but a closer look at the numbers indicates that the net income improvements aren’t as good as they appear. Alphabet and Amazon both include gains from their investments in SpaceX and Anthropic in their net incomes, which has inflated their earnings. Operating income, which isn’t reflected in the P/E ratio, is a more useful metric for reviewing those two companies.
Investment gains are why Alphabet’s net income rose by 298% year over year in the second quarter but its operating income increased by only 30% year over year. This lower figure is a more accurate assessment of how well Alphabet’s underlying business performed.
Microsoft and Nvidia also use this strategy to artificially boost net income. Meta Platforms, Apple, and Tesla avoid this accounting practice, so their P/E ratios more accurately reflect the value of the underlying business.
Smaller companies are achieving higher growth rates
Most of the Magnificent Seven stocks have produced serviceable year-to-date returns, with some of them outperforming the S&P 500. They also tend to have good fundamentals and are well positioned for the AI boom.
However, growth investors who want higher returns might consider smaller companies that are posting high revenue growth rates. Nvidia is the only Magnificent Seven stock that is producing otherworldly revenue growth. The AI chipmaker’s sales rose by 106% year over year in its fiscal 2027 second quarter (ended July 26).
The Magnificent Seven have produced generational returns for early investors, but if you are looking for a stock that can produce generational returns, you should probably focus on smaller companies. It’s easier for a company with a $10 billion market cap to reach a $100 billion valuation than it is for Nvidia to jump from a $5 trillion valuation to $50 trillion. It simply requires far more capital for Nvidia to increase its value 10-fold than it does for a smaller company to achieve that same growth rate.
Smaller companies like Silicon Motion Technology (NASDAQ: SIMO) and Nebius (NASDAQ: NBIS) get my attention because they are more than doubling revenue year over year. They also have smaller market caps and are less well known than the Magnificent Seven. The tech giants are not as risky, but higher returns are available for people who dig for smaller AI stocks.
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Marc Guberti has positions in Apple and Silicon Motion Technology. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool has a disclosure policy.