Which Mega-Tech Will Join the $3 Trillion Market Capital Club Next?

Daniel Morgan, Senior Portfolio Manager

On January 25, Microsoft stock price closed above the mythical $3 trillion market-cap level, joining Apple, which was the first company to reach this milestone on June 30, 2023.  So, the question of technology investors now: Which heavyweight technology stock is poised to eclipse this milestone next –Alphabet, Amazon or Nvidia?

Amazon (AMZN) (Market Cap $1.81 trillion) is the leader in eCommerce and Cloud Computing with AWS (Amazon Web Services), the leading prover of datacenter IaaS cloud services. Services including Prime memberships, third-party sellers, advertising and AWS (these segments will collectively account for 24% of 2024 total revenues) are key drivers of growth and margin expansion. Grocery, healthcare initiatives, media/entertainment and logistics services expand AMZN’s footprint. After a near doubling in capacity in 2019-21 during the COVID-19-demand surge, operating leverage is improving on regionalization, driving lower cost to serve.

The crown jewel beyond AMZN’s core eCommerce marketplace business is AWS. AWS is benefiting from an ongoing adoption of cloud computing (projected to hit 45-50% by 2025). The following is to give you an idea of how impactful AWS is on the overall profit growth for AMZN. During 2023’s first quarter, AWS accounted for $21.4 billion in revenues (representing 16% of total company revenues) plus-16% YoY and generated $5.10 billion in operating income on total company operating income of just $4.774 billion. So, AWS is basically carrying AMZN as its core online North America $898 million and the International ($1.247 billion) segments posted basically neutral operating income during the quarter.

Moving forward, optimizations in the enterprise segment will continue as an ordinary course of business. However, the easy efficiency gains have already been realized, and there is likely not much left that can be optimized. Importantly, the cloud market is maturing, and the law of large numbers means that growth rates will come down over time. AWS is now at a $92 billion run-rate! While Generative Artificial Intelligence (AI) can drive an acceleration, do not expect it to be as sharp as during the pandemic spike. The days of 40-50% AWS YoY growth may be over. Gartner now forecasts worldwide public cloud end-user spending to reach $679 billion in 2024, with all segments of the cloud market expected see growth. Infrastructure-as-a-service (IaaS) is forecast to experience the highest end-user spending growth in 2024 at 26.6%, followed by platform-as-a-service (PaaS) at 21.5%.

Amazon reported strong 4Q23 results with upside across segments and higher than expected margins, with EPS of $1.00 vs. consensus of $0.80. Total revenue grew 13% YoY, led by Advertising that was up 26% and 3P Seller Services up 19%. AWS revenue grew only 13% YoY, in line with estimates, and profits grew 38% YoY as customer cost optimizations continue to moderate and new workload migration is accelerating, featuring larger and longer-term AI commitments. AWS’ recent 13% YoY growth is far cry from the heydays, when AWS revenues regularly posted growth of 30-40% growth. Guidance for total company during the 1Q24 was mixed with revenue growth of 10% vs. estimates of 12%, and operating income of $10 billion versus a $9 billion consensus. Amazon’s overall company revenue growth rate has fallen into the mid-to-low teens as the company enters a mature growth phase.

Alphabet (GOOGL) (Market Cap $ 1.79 trillion) is a leader in online ads and cloud computing (Google Cloud Platform or GCP) with key technologies such as AI/ML/big data; Android & Chrome; and digital content, with YouTube video, music and the Google Play Store. Key growth drivers include Search, YouTube, AI services, SMB eCommerce and Cloud. The Cloud business (GCP) is profitable and gaining share, thanks to investments in the ecosystem and technology differentiation. GOOG’s other bets include healthcare (Verily and Calico) and driverless cars (Waymo).

Alphabet’s core profit driver is its elite market-leading online search digital advertising franchise. Alphabet’s Google Search and advertising marketplace are the gold standard in matching advertisers with available space. GOOGL, when combined with Meta, dominate 70% of the overall online ad market! Digital Ad spend rates for social media and search giants — like Alphabet, Meta, Snap, TikTok and Amazon — should accelerate into 2024 after the immediate pullback in spending following the initial shock of COVID-19.

Since then, there has been a strong recovery in ad spend rates. Visibility beyond a few quarters continues to be murky, though, since digital advertising is extremely sensitive to economic cycles. There are some secular tailwinds, though, as digital advertising continues to grow as a percentage of total advertising dollars. Also, Generative AI can drive advancements in the creation and distribution of personalized digital advertisements, increasing customer ROI. That said, MAGNA forecasts Digital Pure-Play global ad revenue (69% share of total ad spend) to have 10.5% growth in 2023 and 9.4% in 2024.

Alphabet has joined the AI cloud arms race with the likes of Microsoft/Meta and Apple. GOOGL has showcased how AI has been integrated into many different Google services, including Search, Lens, Translation and Maps. Key highlights include: 1) Lens, which combines the power of image and text AI models and used 10 billion-plus times/month, can “search your screen” on Android soon and combine text and image search in multi-search; 2) Maps pairs advanced AI with augmented reality (AR) to power Immersive View — a multi-dimensional framework allowing consumers to experience a location virtually — and Live View, which overlays information such as directions and a nearby point of interest on top of the live camera view. GOOGL has stated that AI is the most profound technology it is working on today.

While Alphabet’s AI strategy sounds encouraging, there is little evidence to show any direct positive impact to overall company profit growth. GOOGL continues to lean on its core online search digital advertising business to drive growth. However, GOOGL reported mixed 4Q23 results, with upside in Cloud and Subscription revenue offset by a slight miss in advertising revenue, and better-than-expected profits excluding charges. Total revenue grew 13% YoY and EPS was $1.64 /$1.72 excluding charges versus a $1.59-a-share consensus. Upside to revenue was led by Cloud (GCP) 26% revenue growth versus estimates of +22% on growing AI traction. The Cloud segment also posted 9% margins versus a loss last year. Subscriptions/Platforms/Devices revenue grew 23% YoY versus estimates of 16% on strong growth in subscriptions and Pixel device sales. GOOGL’s total advertising revenue grew 11% YoY versus estimates for 12%, with inline Search (13%) and YouTube (16%) offset by a miss at Network Partners (down 2% YoY). GOOGL, like AMZN’s epic growth days, are in the rearview mirror as top-line growth hovers in the 10-15% YoY range.

Nvidia (NVDA) (Market Cap $ 1.96 trillion) is the leading graphics processing unit (GPU) manufacturer, with an emerging AI-tech stack across silicon, hardware and software optimized for generative AI and large language models. Key end markets include personal computer (PC) gaming, date center and auto. Expect that AI will become a horizontal technology that will be built into the fabric of cloud datacenter architectures, potentially accounting for 30% of infrastructure versus 10-15% today. NVDA also has a growing software solutions portfolio to develop AI apps, including cloud-based offerings.

The chip industry over the course of the past 11 months has experienced quarter-over-quarter (QoQ) growth after pulling out of a valley in February 2023. Different sectors within the chip space —  cloud/datacenter/AI, telco/enterprise infrastructure, PC/laptops, smartphones and automotive/industrial — are experiencing different paces of recovery. The AI space has experienced the fastest growth as companies like AMD, Broadcom, Intel and Marvell race to introduce chips to compete against market leader Nvidia. Recent estimates from third-party research firms call for industry growth to be comfortably in double-digit territory (Gartner 17%; IDC 20%), while the World Semiconductor Trade Statistics (WSTS) organization has a more conservative view at 13%. All in all, expect positive semiconductor sales growth momentum from the 4Q23 to carry into 2024!

It appears that generative AI spend in the datacenter cloud space is taking priority over the transition to newer, more expensive platforms, as general CAPEX in cloud slows. How is this growth even possible in the context of 2023 cloud budgets that appear up only slightly? Anecdotes, quantitative modeling and common sense all lead to the same conclusion: cloud customers are rapidly shifting budgets toward AI, so this strength is coming at the expense of traditional servers and other legacy areas.

For example, CAPEX spend rates in the datacenter space lead to all the top IaaS cloud units to post slower growth rates in the 4Q24. Yet, Nvidia seems to be bucking this cap-ex general slowdown as the increase usage of AI chips in the datacenter cloud space is providing a catalyst. It has been estimated that approximately 65% of NVDA’s overall datacenter revenues are driven by generative AI with 90% of that coming from deep learning and 10% from inference.

Given the strong demand for its datacenter products, Nvidia has extended visibility for the next several quarters and has secured more supply to support significant revenue growth in the 2H24. Next-generation products are an important driver of order activity, lead times and competition. Nvidia recently announced a new AI GPU, the B100 Blackwell, which will be a substantial upgrade from H100. The B100 is system-compatible and will be priced more aggressively than initial expectations. Nvidia is quite motivated to use B100 to blunt the momentum of competition from AMD/INTC/MRVL. Nvidia’s Data Center segment now generates more revenues than both INTC’s and AMD’s combined datacenter units! Nvidia’s datacenter business is expected to nearly double its revenues in FY2025 to $80.9 billion, up from $45.9 billion in FY2024 with AI being the major catalyst! On the PC front, Nvidia recently unveiled AI-enabled PC GPUs. With NVDA’s current 100 million-plus GeForce RTX gaming GPU installed base, NVIDIA is well positioned to capitalize on the proliferation of AI computing at the PC. On the horizon: Nvidia’s new RTX 40 Series SUPER GPUs, including: the flagship RTX 4080 SUPER; and the RTX 4070 Ti and RTX 4070 SUPER.

Nvidia recently reported 4Q24 results that beat Wall Street’s forecast for earnings and sales, even against elevated expectations for massive growth. Nvidia reported earnings per share of $5.16 adjusted versus a $4.64 estimate and revenue of $22.10 billion as opposed to a $20.62 billion estimate. Nvidia said it expected $24.0 billion in sales in the upcoming 1Q25, which is above the previous $22.17 billion estimate. 

On a call with analysts, Nvidia CEO Jensen Huang addressed investor fears that the company may not be able to keep up the growth or level of sales for the whole year.

“Fundamentally, the conditions are excellent for continued growth” in 2025 and beyond, Huang said. He added demand for the company’s GPUs will remain high due to generative AI and an industry-wide shift away from central processors to the accelerators that Nvidia makes. Nvidia’s total revenue in the 4Q24 rose 265% from a year ago, based on strong sales for AI chips for servers, particularly the company’s “Hopper” chips such as the H100. With the Hopper architecture, Nvidia is selling an entire “AI Foundry” system including chips/hardware/software for cloud, enterprise and sovereign customers.

Nvidia has become the poster child for AI chips. Can Nvidia continue to grow the top line at 265%, like the recent growth exhibited during the 4Q24 print? We will have to see! Nvidia’s tremendous current success makes future YoY Sales/EPS comparisons more challenging. However, when we compare Nvidia’s current YoY 200%-plus sales growth to both Amazon and Alphabet’s top-line growth of just 13%, it is clear that Nvidia is in a different growth cycle phase. Nvidia is only at the beginning crest of a massive AI chip wave.

While both Amazon and Alphabet continue to rely on their core businesses — Amazon’s eCommerce Marketplace and Alphabet’s online search digital advertising franchise — to sustain growth. Both Amazon and Alphabet have AI strategies and products, but it is extremely difficult to parse through the financials and find any meaningful catalyst to either sales or profits directly related to AI.  Overall, we’re viewing  Amazon and Alphabet at the trough of a wave that has been playing out over many years — still in search of the next big wave!