“That’s Where the Growth Is”: Dave Mazza on the Magnificent Seven

Dave Mazza, Chief Strategy Officer at Roundhill Investments, speaks to OPTO Sessions to explain the bull investment case for the magnificent seven stocks. He argues that these stocks are reasonably priced when growth is factored in, and that their profit margin growth justifies their soaring prices.

Dave Mazza is Chief Strategy Officer at thematic ETF manager Roundhill Investments. In this role, he leads the firm’s product development, capital markets and research functions.

He was previously Managing Director and Head of Product at ETF provider Direxion, and has held positions at OppenheimerFunds and State Street. He has a bachelor's in political science and philosophy from Boston College and an MBA in finance from the Sawyer Business School at Suffolk University.

Mazza is a frequent guest on financial media channels including CNBC and Bloomberg.

In this conversation, he focuses on the ‘magnificent seven’ stocks — Alphabet [GOOGL], Amazon [AMZN], Apple [AAPL], Meta Platforms [META], Microsoft [MSFT], Nvidia [NVDA] and Tesla [TSLA] — in light of their incredible performance relative to broader markets during 2023, and how that shapes the current investment case for them.

Strength in Numbers

What makes the stocks as a group stand out from the broader market is the resilience of their revenue and earnings growth numbers.

“If you look at the longer-term picture,” says Mazza, “their growth has been significantly stronger than the market. It has been relatively consistent at a time when growth has been hard to find.”

The resilience of the magnificent seven is particularly noteworthy in contrast to other technology and growth stocks in the aftermath of the Covid pandemic: “Tech as a group did exceptionally well during Covid,” but “that came to a screeching halt in 2022”.

Mazza explains that investors taking a traditional approach to growth investing will often focus on metrics such as high return on equity (ROE) or strong efficiency ratios. “A lot of those companies that traditionally have strong ROEs can also come with a lot of debt in this market,” says Mazza. This means that they are particularly sensitive to interest rates, especially if they aren’t yet profitable.

“Those unprofitable companies are not being rewarded by the market. They don't really have what I consider to be a catalyst, absent material rate cuts, or even quantitative easing, to see their multiples expand.”

By contrast, the consistent performance of the magnificent seven across market conditions acts as a catalyst for expanding multiples.

The recent success of the Magnificent Seven is also, in part, thanks to their diversification into new business domains over recent years.

“Alphabet is not just Google search,” he says. “Whether it's YouTube or other investments that they've made, they are starting to pay off.”

“Those unprofitable companies are not being rewarded by the market. They don't really have what I consider to be a catalyst, absent material rate cuts, or even quantitative easing, to see their multiples expand.”

Apple and Tesla offer investors a consumer goods play, according to Mazza, while he views the relative newcomer Nvidia as akin to an infrastructure play.

The (Over-)Concentration of the Magnificent Seven

The Magnificent Seven’s outsized returns compared to the broader market during 2023 were a cause of concern for some investors. The group accounted for 73% of total stock market gains during the year, and by the end, it comprised 28% of the value of the S&P 500.

Two things about this concentration stand out to Mazza. Firstly, he believes that it highlights some of the drawbacks of market cap (as opposed to equal-weighted) indices. “This isn't the first time we’ve seen it,” he says of this level of concentration, although “they are now at greater extremes”.

Mazza explains that this leads to a greater potential risk of over-valuation.

“On a relative basis, these companies are not really as expensive as some may think, but they’re not cheap at all. To be totally fair, they’ve been rewarded with stronger growth multiples... But if you were to look into the future and extrapolate these current growth rates, plus the growth rate of the multiple, then you run into valuation concerns.”

Mazza advocates assessing the stocks’ values not just through their price-to-equity ratios, but through “something like the price/earnings-to-growth ratio”, so that growth is incorporated.

“On a relative basis, these companies are not really as expensive as some may think, but they’re not cheap at all.”

However, the stocks cannot continue to gain in price while increasing their valuation multiples forever.

“We’re not quite there yet,” he adds.

Marginally More Bullish

A team of analysts at Goldman Sachs, led by partner and Chief US equity strategist David Kostin, wrote on 5 February that their abilities to maintain sales growth will be the key determinant of whether the magnificent seven continue to outpace the broader market.

Kostin expects the group to grow sales at an annualised rate of 12% through 2026, based on an analysis of consensus estimates, compared to 3% for the other 493 S&P 500 constituents.

Mazza is “slightly more” bullish than this, but otherwise agrees with the gist of the report. While it acknowledged both the overconcentration and projected earnings growth rate questions that many investors have identified, the report, in Mazza’s view, “took it a step further, and quantified that quality growth or quality revenue, and then looked at margins.

“The year-over-year margin growth of these companies is really impressive,” says Mazza. According to Kostin’s analysis, the Magnificent Seven’s margins have grown 747 basis points, while the other 493 companies have contracted 110 basis points.

“When you put the numbers in front of you, even if it's uncomfortable to say, ‘Man, seven stocks are driving everything,’ they’re driving things for a reason: because that’s where the growth is.”