Big Growth. 'Undemanding' Prices. Are Big Tech Stocks Value Plays These Days?

Key Takeaways

• Morgan Stanley analysts on Wednesday maintained their endorsement of hyperscaler stocks, which they argue offer investors exceptional earnings growth at “undemanding” prices.

• The analysts expect investors will continue to focus on the tech giants’ revenue growth, which accelerated across the board last quarter, rather than their ballooning AI budgets.

The tech stock rally may have taken a breather this week, but analysts expect that break means Big Tech has more room to run. 

Morgan Stanley analysts on Wednesday named the hyperscalers—Alphabet (GOOG), Microsoft (MSFT), Amazon (AMZN), and Meta (META)—among their preferred stock plays, citing the group’s “strong forward earnings at undemanding valuation levels.”

The firm first made the case for the hyperscalers as value plays in early April, around the same time as Goldman Sachs. Soaring oil prices and rising risk aversion caused the Magnificent Seven—the hyperscalers plus Nvidia (NVDA), Apple (AAPL), and Tesla (TSLA)—to pull back nearly 10% in the first month of the war in Iran. Analysts simultaneously increased their earnings growth forecasts, causing the group’s stock valuations to slide to their lowest levels since Liberation Day. By early April, the Mag 7 was only marginally more expensive than the Consumer Staples sector even though its profits were expected to grow three times faster, according to Morgan Stanley.

Why This Matters To Investors

The Magnificent Seven came to be in 2023 when the tech giants’ growth began accelerating and their stocks left of the rest of the market in the dust. They remain America’s most influential stocks, accounting for more than one-third of the S&P 500.

Earnings reports from the hyperscalers last month confirmed what analysts suspected: Business is booming. Cloud growth accelerated to multi-year highs at Alphabet, Microsoft, and Amazon. Meta reported its fastest revenue growth since 2021. 

Strong results have helped keep the hyperscalers’ valuations “undemanding” despite big run-ups in their share prices, according to Morgan Stanley. The Roundhill Magnificent Seven ETF (MAGS), a measure of the performance of the group broadly, is up 27% since late March. Yet the Mag 7 trades at just a 30% premium to the S&P 500 on a forward price-to-earnings basis, down from more than 70% in 2023 and and a low level historically.

Still, the recent run-up in tech stocks and the hyperscalers’ ballooning infrastructure budgets have revived fears that an AI bubble is forming. The hyperscalers are expected to boost their infrastructure spending by 60% this year, to more than $700 billion. That increase is expected to pressure their already dwindling free cash flows, and some investors worry they’ll struggle to recoup those investments.

Such concerns have arisen repeatedly over the years, but have yet to derail the AI rally. According to Morgan Stanley, investors are unlikely to punish the hyperscalers for their AI spending in the near-term. The tech giants haven’t borrowed much to build their data centers, and thus face minimal risk that higher interest rates will drive up costs. Plus, their cloud computing services are in high demand. As long as these conditions persist, Morgan Stanley expects investors to focus more on revenue growth than capital expenditures or free cash flows. 

And Morgan Stanley sees strong revenue growth ahead. “Our proprietary analysis shows that momentum continues to build around AI adoption,” the analysts wrote. The more businesses and consumers experiment with AI and develop new use cases, the greater the revenue tailwinds for the hyperscalers whose platforms host the technology. 

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