A low-key headwind for the mega-cap tech stocks: Morning Brief

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Tuesday, Nov. 15, 2022

Today’s newsletter is by Sam Ro, the author of TKer.co. Follow him on Twitter at @SamRo. Read this and more market news on the go with Yahoo Finance App.

Every big company would love to invent the next hot good or service that becomes a key driver of sales and earnings growth.

Unfortunately, this can be a costly, money-losing endeavor if your R&D department stinks.

But companies with access to financing have another option: acquire growth.

Acquiring a company for its intellectual property will almost always cost more than if you had invented it on your own. But developing products comes with lots of costly failures in the same way that many startups fail. And so it may effectively be cheaper to acquire a company that has established some success.

These deals can be particularly lucrative if the acquirer has better resources to scale up an acquisition target while cutting out redundant costs.

Indeed, this helps to partly explain how the world’s largest tech companies came to be so big. Google-parent Alphabet didn’t always own YouTube, a business that generated $7 billion in revenue in Q3.

In a research note published on Friday, Goldman Sachs’ David Kostin noted that the acquisitive tendencies of Apple, Amazon, Microsoft, and Alphabet have “slowed sharply.”

These companies continue to acquire a lot of businesses — Microsoft said this year it plans to buy video game giant Activision Blizzard for an eye-popping $68 billion. But the volume of acquisitions has trended lower in recent years.

“Tighter antitrust scrutiny appears to have slowed acquisition activity among the group,” Kostin wrote. “Thus far in 2022, the four firms have announced just 22 acquisitions, less than half the number five years ago.”

The higher interest rate environment can’t be helping either as financing deals has become more costly.

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Kostin notes that it’s “difficult to estimate the role acquisitions in prior years played in driving the sales growth of the major tech firms.”

But the slow-down in acquisitions probably isn’t helping growth.

“The one characteristic most associated with large cap tech stocks — superior sales growth — has vanished, at least for this year,” Kostin wrote. “Mega-cap tech firms generated remarkably high average annual sales growth of 18% during the past decade… Aggregate sales growth for mega-cap tech is forecast to rise by 8% this year…”

Of course, not all acquisitions work out. Many prove to be less profitable than expected, which often leads to big write-downs. And so, not being able to acquire a big company isn’t necessarily the worst thing in the world.

In the end, the effect of tighter antitrust scrutiny and higher interest rates might have only a small impact on the growth prospects for these tech giants. Still, every headwind — even a low-key one like this — makes it more difficult for these companies to meet the high growth expectations of investors.

What to Watch Today

Economy

• 8:30 a.m. ET: Empire Manufacturing, November (-6.0 expected, -9.1 during prior month)

• 8:30 a.m. ET: PPI Final Demand, month-over-month, October (0.4% expected, 0.4% during prior month)

• 8:30 a.m. ET: PPI Excluding Food and Energy, month-over-month, October (0.3% expected, 0.3% during prior month)

• 8:30 a.m. ET: PPI Excluding Food, Energy, and Trade, month-over-month, October (0.3% expected, 0.4% during prior month)

• 8:30 a.m. ET: PPI Final Demand, year-over-year, October (8.4% expected, 8.5% during prior month)

• 8:30 a.m. ET: PPI Excluding Food and Energy, year-over-year, October (7.2% expected, 7.2% during prior month)

• 8:30 a.m. ET: PPI Excluding Food, Energy, and Trade, year-over-year, October (5.6% expected, 5.6% during prior month)

• 9:00 a.m. ET:  Bloomberg Nov. United States Economic Survey

Earnings

• Home Depot (HD), Walmart (WMT), Advance Auto Parts (AAP), Energizer (ENR), Krispy Kreme (DNUT), Tencent Music (TME)

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