‘Magnificent Seven’ under Pressure: Focus on Opportunities and Risks for Amazon and Apple

The fear of a recession returned last week after a disappointing labor market report raised the question of whether the Federal Reserve waited too long to cut interest rates. These concerns pushed the Nasdaq Composite into correction territory, meaning that the technology-oriented index has fallen at least 10% from its record high. Particularly, the so-called "Magnificent Seven" stocks experienced double-digit declines, with some more affected than others. Amazon lost 20% from its peak, while Apple fell by 11%. Investors might be tempted to buy the dip in both cases, but not every decline is a buying opportunity. Amazon's stock currently trades at a reasonable valuation, whereas Apple stock still appears expensive. Here are the key details: Amazon has a strong presence in three major markets. It operates the most popular e-commerce marketplace, measured by monthly visitors. It is the third-largest advertising company in the U.S., and eMarketer predicts that Amazon could overtake Meta Platforms for the second spot by the end of the decade. Finally, Amazon Web Services is the market leader in cloud infrastructure and platform services, meaning it is well-positioned to monetize artificial intelligence (AI). In the second quarter, Amazon reported mixed financial results. Revenue rose 10% to $148 billion, missing Wall Street's forecast of $148.6 billion. However, net income calculated according to generally accepted accounting principles (GAAP) climbed 94% to $1.26 per share, exceeding the expected $1.03 per share. Unfortunately, management issued a somewhat disappointing forecast. The company expects operating profit to grow by 18% in the third quarter, whereas analysts expected 37% growth. This shortfall contributed to the recent decline in the stock price but creates an opportunity for patient investors. Amazon continues to have strong growth prospects in e-commerce, digital advertising, and cloud computing industries. Retail e-commerce revenue and digital advertising spending are projected by eMarketer to grow annually by 8% and 10%, respectively, by 2027. Public cloud service revenue is expected to rise by 19% annually through 2028, according to IDC. These elements give Amazon good chances for double-digit revenue growth in the coming years, which should translate into somewhat faster profit growth as the company continues to optimize operating costs. In fact, Wall Street expects earnings per share to increase by 23% annually through 2027. This makes the current valuation of 38.5 times earnings reasonable. These numbers yield a PEG ratio of 1.7, a significant discount to the three-year average of 2.9. Patient investors should feel comfortable buying a small position in Amazon today. Apple divides its business into two revenue streams: products and services. The former includes revenues from consumer electronics like iPhones, iPads, and Mac computers, while the latter includes revenues from the App Store, Apple Pay, iCloud, and subscription offerings like Apple TV+ and Apple Music. The company is strong in several of these markets. Apple consistently ranks second and fourth in quarterly smartphone and personal computer shipments. It operates the leading mobile app store by revenue and has converted this leadership into a thriving advertising business. Furthermore, Apple Pay is the leading mobile wallet for in-store transactions among U.S. consumers, and Apple TV+ recently surpassed Paramount Global's Paramount+ as the sixth most popular streaming service in the U.S. However, Apple also faces headwinds. The recently passed Digital Markets Act could harm its App Store dominance in Europe by forcing it to support third-party app stores. Additionally, Apple is losing smartphone market share to local competitors in China. iPhone shipments in the region dropped 3% in the second quarter, despite growth in the broader market. This is concerning since China accounted for 19% of Apple's revenue last year. Lastly, Apple lacks a clear strategy in the AI space. It plans to introduce Apple Intelligence in October to bring AI features to iPhones and MacBooks. Aside from potentially spurring product upgrades, management has not detailed plans for future monetization. Bloomberg speculates that Apple may charge for certain AI features, but whether consumers will pay remains uncertain. In the June quarter, Apple reported modest financial results. Revenue rose 4.8% to $85.8 billion, and GAAP net income increased 7.6% to $21.4 billion. Active devices reached an all-time high across all product and geographic segments, and service revenues climbed 14% to a record $24.2 billion while the gross margin rose by 180 basis points. In short, Apple is effectively drawing consumers into its hardware ecosystem and monetizing them with high-margin services. However, the problem remains its valuation. Apple stock currently trades at 31.8 times earnings, a premium to the three-year average of 27.8 times earnings. This valuation appears particularly high given that Wall Street expects earnings per share to grow by 9% annually over the next three years. This high valuation might explain why Warren Buffett has reduced Berkshire's stake in Apple over recent quarters. Investors should avoid this stock at present.