Meet the ‘Trillion Dollar Club’: How 5 companies took over the S&P 500—and likely your portfolio
In the 18 months before the pandemic struck, four corporate superstars joined the most exclusive group in the world of business: the Trillion Dollar Club.
In that year and a half, Apple, Microsoft, Alphabet, and Amazon all crossed the 13-figure bar in market cap. In each case, they won entry because the market was already anticipating exceptional bottom-line performance in the years ahead. Though Apple was posting the highest sustained earnings in the annals of capital markets, investors awarded the iPhone-maker a valuation based on the forecast that its profits would advance in the mid–single-digits, on that already gigantic base, far into the future. Microsoft was pocketing almost as much as Apple, yet it sported a lofty price/earnings ratio of 35 early last year, signaling that folks and funds were counting on a fast ramp from there. Google ranked third behind those two club mates in S&P 500 earnings for 2019, yet it too boasted a premium, 30-plus multiple, auguring that only rapid expansion would deliver decent returns.
Amazon was by far the lowest earner of the group. But its $1.1 trillion cap in February of 2020 stood only 20% below those of Apple and Microsoft. Investors were paying $94 a share for each $1 in profits; hence, they expected Amazon’s earnings to absolutely explode going forward.
In the pre-pandemic economy, each member of the Trillion Dollar Club dominated its market: Apple in smartphones, Microsoft in cloud computing, Alphabet in internet advertising, and Amazon in online retail. The question was whether their immense power could persist, enabling them to keep swelling their sumptuous overall profits at a pace that would drive their stocks higher still. That’s what Wall and Main Streets believed in opening the Trillion Dollar Club. “Even then, these companies had been growing fast for a long time,” says Vitali Kalesnik, director of research in Europe for Research Affiliates, a firm that oversees investment strategies for $171 billion in mutual funds and ETFs. “The big question was whether these ‘top dogs’ could keep it up or be toppled by newer players vying for their huge profits and market shares.”
Instead, the quartet that broke the trillion-dollar barrier absolutely boomed during the pandemic, far surpassing the market’s already great expectations. Both their sales and margins raged, lifting those already giant profits to levels that awed even their fans among analysts and market strategists. Put simply, the work-and-buy-from-home economy disproportionately rewarded the charter members. The reason is threefold. First, the multitrillions in stimulus payments that swelled Americans’ bank accounts during the crisis had to go somewhere, and much of it bought products and services that gained vast new popularity in the lockdown. Second, slender interest rates provided a giant boost to the top growth companies, in part because they raise the value of earnings heavily weighted toward the future, especially in the case of Amazon. The speculative craze opened the portal to a new member, Tesla, the ultimate example of paying big now for profits that need to wax at incredible speed far into the future.
Third, the sectors that thrived in a pandemic era were precisely those that trillion-dollar contingent rules. Amazon prospered as families switched en masse from shopping at stores to buying online, and flocked to stream its series on Amazon Prime; Google’s ad business flourished as folks stayed glued to the computer screens in their home offices; and Apple and Microsoft garnered a bonanza selling the IT gear and cloud services that power the work-from-home economy. The rise of social media “influencers” in the pandemic helped spawn the bull market in belief that just welcomed Tesla to the club.
The rub: While it was a stretch in pre-COVID days to project that these highfliers could generate profits big enough to justify, in four cases, their trillion-plus valuations, getting there now looks even more like a reach-too-far. And as for Tesla, a long membership looks mathematically impossible, given that it would need to control two-thirds to over 100% of the EV market by 2030 to justify its $1.1 trillion cap. Though Tesla’s profits are tiny versus its valuation, the Trillion Dollar Club overall is boasting what are probably bubble earnings, profits so out of whack with the basics that they’re destined to fall from here. Even though that’s what the fundamentals say, that’s not how the market’s voting. Investors are paying even more for every dollar of those highly inflated earnings than before the pandemic run-up began. Today, the Trillion Dollar Club provides the most extreme example of the market’s paramount problem: U.S. big-caps feature high price/earnings ratios on profits that not only far exceed past summits, but dwarf almost any other periods in such bedrock measures as net income as a share of sales. And the main culprit in creating the “rich valuations on top of bubble earnings” obstacle for big-cap stocks is the heavy betting on the Trillion Dollar Club members themselves.
How the club first hit $1 trillion, then jumped in a flash to $2 trillion
It’s surprising to recall that less than four years ago, the world hadn’t seen its first trillion-dollar, publicly traded enterprise. At the close of 2017, the most valuable player on earth was Apple at $861 billion, and only five companies’ worth exceeded half-a-trillion. The prospects for a $2 trillion champ anytime soon seemed remote indeed.
Apple arrived, first hitting the mark on Aug. 7, 2018, and by our definition, Microsoft was second to join, ringing the bell in April of 2019. Amazon briefly reached 13 figures just one month later than Apple in the summer of 2018, but then retreated and didn’t reach $1 trillion and keep rising until July of 2019. So we’ll call it third to win membership. Most recent to don the club crest is Alphabet; it crossed the portal on Jan. 16, 2020, just a month before the crisis struck. Then the COVID economy supercharged both their earnings and share prices. Three of the four got their portraits displayed in the paneled library by hitting $2 trillion. Apple triumphed first, on Aug. 19, 2020, a mere two years after exceeding a single trillion. Next came Microsoft on June 22 of this year, and Alphabet clinched what the champs might call “two units” on Nov. 9.
Two weeks earlier, on Oct. 25, Tesla entered the Trillion Dollar Club, propelled by a strong Q3 earnings report, and Hertz’s pledge to buy 100,000 Teslas. That news helped boost its market cap by almost half-a-trillion dollars in three weeks, the biggest increase over a brief period in the history of equity exchanges. Then CEO Elon Musk sent Tesla’s shares into retreat by calling the Hertz deal into question, and declaring via Twitter his plans to sell 10% of his shares. But as of late afternoon on Nov. 11, Tesla was still seated at the club’s bridge table at a valuation of $1.06 trillion.
The Trillion Dollar Club vastly outperforms the raging overall market
Let’s examine where the Trillion Dollar Club stood at the beginning of the crisis, versus the current weight of its earnings and valuation in the S&P 500. For this analysis, I’ll include Tesla in recognition of its current membership, though it hadn’t yet joined at the start of the pandemic. Our starting date: Feb. 19, 2020, when the S&P notched an all-time high of 3386. Since then, the index has gained 37%, closing on Nov. 11 at 4653. Over that 18-month span, all of the hard-partying clubsters beat the market; Amazon rose 46%; Microsoft, 78%; Apple, 84%; Alphabet, 93%; and Tesla, 480%.
To gauge how their rising girth tilted the market, we’ll consider the group as a single company, Trillion Dollar Inc. As of February of last year, the group’s market cap totaled $5.138 trillion. That already marked the culmination of sterling performance across many years. Trillion Dollar Inc.’s share of the S&P 500’s then overall market cap of $26.8 trillion was 19.2%, and its combined earnings were $141 billion. Hence, its P/E multiple hovered at 36.4, meaning investors expected substantial profit growth in the years ahead.
And that’s what they got, courtesy of the New Economy. Over that tumultuous year and a half, net GAAP profits swelled from $141 billion to $257 billion, a jump of $116 billion or 82%. That’s 40% a year on an annualized basis. But Trillion Dollar Inc.’s market cap rose even faster, from $5.138 trillion to $9.76 trillion for a gain of 90%. Hence, its P/E rose from the high bar of 36.4 to the daunting bogey of 38. That hike showed that investors were positing even higher profit growth than their already high benchmarks before the pandemic. Their wager: Earnings that had grown 80% in less than two years would keep rocking. See what I mean about towering valuations atop outsize earnings?
The club has made the overall market a lot more expensive
Over this period, earnings for the entire S&P 500 also rose sharply, going from $1.15 trillion to $1.48 trillion, an increase of $300 billion or 29%. But Trillion Dollar Inc.’s profits raced three times as fast. Our elites contributed $116 billion or an astounding 35% of the big-caps’ overall leap. The 500’s total valuation also waxed strongly from $26.8 trillion to $39.5 trillion. But the Trillion Dollar crowd far outpaced that 47% march by a roaring 90%. As a result, their $4.6 trillion advance accounted for 36% of the index’s entire progress.
The upshot is that the Trillion Dollar Club’s outperformance had two effects. First, it gigantically raised the S&P’s profit base, contributing greatly to what looks like a profit bubble. Second, its valuation rose so fast, even relative to earnings, that it helped make the S&P 500 superexpensive. The other 450-odd companies are trading at a P/E of 24.3; but the members’ royal multiple of 38 lifts the overall number to 26.7, or 10%. And since their shares account for 36% of the S&P’s valuation, a drop of 20% in Trillion Dollar Inc. would hammer the index by nearly 8%.
Margins that are impossible to sustain
It’s especially instructive, and scary, to compare the club’s profit margins to their pre-COVID levels, and where they sit alongside those of the 490-odd members of the S&P. In February of 2020, the S&P booked a net profits-to-sales ratio of 9.8%, and the club was delivering 16.5%. Both were already well above historical norms. But in Q3 of this year, the 500 hit 11.7%, and, get ready, the club registered 20.1%. Put another way, the club’s getting 20.1% margins, and the other 90% of the S&P 500 are reporting 9%, a number that’s well above the average for the past two decades.
The trend is dangerous, because the club accounts for just 10% of the S&P’s sales. To be sure, its members have long furnished a far bigger portion of profits than its share of revenues. But in the pandemic, their weight in the S&P’s market cap expanded far more than their size in the economy, as measured by revenues. Investors in big-cap index funds are now parking at lot more of their money in club stocks that are extremely expensive, especially when measured against an earnings blowout that will probably reverse. And the higher the club’s prices go, the more of them investors in passive funds will own.
It’s certain that the club’s great brands and market leading technologies, and in the case of Microsoft, Alphabet, and Apple, capital-light models, should be posting well above average profitability. What’s troublesome: 20% margins of net income to sales are far too big to last. It beats the club’s combined results in the pre-COVID years by something like 40%. As Kalesnik says, profits that big are a magnet for competitors. The pandemic economy provided a gigantic windfall for shooting stars that were already due for a rush of fresh competition, and probably a slowdown, before the lockdown radically changed how families shopped, and what they shopped for. Loads of demand stepped forward that won’t be repeated. Kalesnik notes that few “top dogs” rule their markets for much over a decade. The pandemic pushed the club into a new gear just when its rampage might have slowed.
The most likely scenario: The Trillion Dollar Club’s profits will drop or at least go flat. In the latter case, they’d decline in “real terms” by trailing inflation. The club’s new, far heavier weight in the S&P 500 is likely to make a looming drop much more severe than if their valuations didn’t stand at such a vertiginous multiple of towering, peak profits. The rise of these top dogs to the Trillion Dollar Club has been one of the great spectacles of the past three years.
By putting three players in the gilded, trillion-dollar clubhouse, and two others in the $2 trillion commodore’s circle, the market has lifted hurdles for future performance so high that the members will struggle to deliver decent returns. Investors are giving the members super-low handicaps, wagering they’ll clinch scores in the club golf championship they probably can’t achieve. Young rivals tuning up on the public courses are aching to lower their status on the club’s rolls, or even bump them from capitalism’s new pantheon.
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