In recent weeks, the U.Sstock market has seen a notable pullback, particularly affecting the market capitalizations of major technology companiesAnalysts are starting to express pessimism regarding the sustainability of the tech bull market, with some predicting that a bubble may be on the verge of bursting.

Additionally, the President of the Federal Reserve Bank of Minneapolis recently stated that if the U.Seconomy continues to show strength, the Federal Reserve may not need to lower interest rates this yearThis has led to an increase in market anxieties about the potential bursting of growth-related bubblesWith a prolonged macroeconomic environment characterized by high-interest rates, the so-called “Magnificent Seven” tech giants need to demonstrate robust performance consistency to support further stock price appreciation, especially at valuations hovering around 30 times earnings.

However, prominent investor Bill Miller’s former partner, Samantha McLemore, founder and Chief Investment Officer of Patient Capital Management, argues through a recent paper that while we may eventually fall into a tech bubble, we are far from that point at present

“In fact, we still believe that some of the companies among the 'Magnificent Seven' are quite attractiveWe hold positions in Alphabet, Amazon, and Meta, and we purchased Nvidia in the first quarter.”

The premiums for some of these tech giants are deemed reasonable

and might even be undervalued.

Currently, the fluctuations of the “Magnificent Seven” are severely impacting the performance of numerous passive index fundsWith the recent downturn in U.S

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indexes and tech company stock prices, some analysts suggest that the tech bull run may be concludingThis stems primarily from the belief that the stellar performance of these tech companies cannot be maintained indefinitely; for example, Tesla recently reported first-quarter sales that fell short of expectations, showing a year-over-year decline for the first time in four years.

Another major source of concern for the market is that if Google, Amazon, or Apple also underperform in terms of fundamental data, it could result in a collapse of market sentiment, causing stock prices to tumble like a house of cards.

In response to these anxieties, McLemore has compared the fundamentals of the “Magnificent Seven” alongside market expectations to analyze their opportunities and risks.

These tech giants boast exceptionally high rates of return on capital, profit margins, and attractive growth rates

McLemore summarizes that over the past decade, these companies have achieved a compound annual growth rate in revenue of 24%. Earnings per share (EPS) have compounded at a rate of 33%, with free cash flow growing at an impressive 41%!

Such rapid growth and high capital returns have indeed driven these companies’ valuations higherNotably, after excluding Tesla, the average price-to-earnings (P/E) ratio rose only by two multiples, from 23 times to 25 times“Shockingly, the relative trading price of the 'Six Giants'—excluding Tesla—has actually declinedBack in 2013, they traded at 1.5 times the market average, but currently, that figure stands at 1.25 timesGiven that they continue to maintain strong growth rates, profit margins, and capital returns, we believe such a premium is justified, or perhaps even slightly too low.”

The one overvalued player is Tesla

as its market expectations appear disconnected from its fundamentals.

Stock movements are directly tied to future performance

According to McLemore, considering the typical 20-year competitive advantage period that tech firms enjoy, and assuming a 2023 operating profit margin (calculated at 12% for Amazon), the estimated compound annual growth rate for revenue for the “Magnificent Seven” is approximately 10%. If Tesla is excluded, the estimation drops to 8%.

McLemore further indicates that if you believe 20 years is excessively long, considering many businesses may not survive that duration, the figures for a 10-year period yield estimations of 17% and 13%, respectivelyShortening it to a 3-year outlook, the projected annual growth rate for the “Magnificent Seven” sits at 16% (as Tesla is expected to survive past three years, calculations focused solely on the “Magnificent Seven”).

McLemore’s calculations indicate that, based on such growth rates, there are discrepancies in market expectations

The market seems to overly estimate risks while undervaluing returns, presenting potential investment opportunities.

Specifically, it appears that market expectations for Amazon’s revenue are too lowMcLemore posits that Amazon's competitive advantage could extend beyond ten years, potentially reaching twenty, which might lead to improved profit margins.

Alphabet, on the other hand, faces intense competitive pressure, with its revenue growth rate hovering below half of the three-year average (14%) at just 6%. Despite this, McLemore maintains a relatively optimistic stance, believing that Alphabet will adapt to this competitive landscape.

According to McLemore's assertions, Patient Capital Management purchased Nvidia stock at an average price of $550 early in the first quarter, driven by a bull case that cites limited hardware supplies, software development platforms, and an accelerating innovation cycle that places Nvidia at a significant advantage in the early stages of the computing revolution

“We see more parallels between Nvidia and Microsoft than with CiscoWe expect the market to price Nvidia’s future fundamentals in line with MicrosoftWhile most companies may fall short of these expectations, Nvidia is capable of meeting them.”

When it comes to Tesla, the market’s valuation is pegged at 38 times earnings, which McLemore considers excessive“It’s difficult to justify this expectation as the current penetration rate of full self-driving (FSD) is under 10%, and operating profit margins are in the single digits, akin to traditional automakers.

To sustain this valuation, you would need to believe in an annual revenue growth of 15% for Tesla over the next 20 years, with a terminal operating profit margin of 22% (which implies delivery volumes three times that of Toyota, with FSD at 30%), or you would need to assert that Tesla’s software system can generate substantial income.”

“There is a clear disconnection between market expectations and fundamentals,” McLemore states, supporting her pessimistic view regarding Tesla’s outlook.

Among the remaining members of the “Magnificent Seven”—Meta, Microsoft, and Apple—analysis from Patient Capital Management suggests that their valuations fall within a reasonable range

McLemore emphasizes, “We hold Meta and will continue to do so, letting the winners run.” Currently, Apple's growth expectations exceed the three-year consensus of 4%. Considering its brand power and pricing ability, achieving a revenue growth rate of 5% over the next 20 years appears quite feasible if it maintains its market position.

Microsoft is also expected to reach performance targets over the next 20 years similar to those of the last decade, albeit with a slight decrease in growth of 1-2 percentage points, which again falls within a rational bandwidth.

(The stocks mentioned are solely for analytical illustration and are not suggestions for buying or selling.)