The Magnificent 7 versus the other 493 S&P 500 companies: What’s the better investment?

The reason: the world relies on technology—and these companies, in one way or another, are a part of our daily lives. Still, the uneven performance over the past year has left some Canadian investors wondering if they should continue to invest in the Magnificent 7 or buy stocks of the other 493 companies that make up North America’s largest stock market index, the S&P 500.

Personally, I don’t view this as an either-or situation. I think Canadian investors should be looking at both sides—all the time. Not just when the markets fluctuate.

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Big tech in 2024 and how we got here

The Magnificent 7 and other large-cap tech companies had a tremendous run coming out of 2022. That’s when the central banks in North America and Europe stopped raising interest rates, and generative artificial intelligence (AI) and ChatGPT emerged as game-changers. In 2023, the markets were off to the races, led by the tech sector and particularly the companies that design, build and use the computer chips that make generative AI possible.

In 2024, Big Tech continued to be on a roll until March. In the spring, it started to slip, causing the markets to dip and investors everywhere to worry about a possible correction. Instead, the markets rebounded in May. In July, the Magnificent 7 took the markets to new heights at the start of the month before a selloff at the end of the month, leading to an even steeper fall for the markets.

And, so, here we are again. Investors around the world are questioning just how much bigger the Magnificent 7 can get and if it’s time to focus on other sectors.

Why tech and Magnificent 7 stocks may still be good investments

When I design a portfolio, I look for three things:

1. Protection,
2. dividend income,
3. and growth.

This is how I diversify, and this is why I think every portfolio needs to have some large-cap companies—including the Magnificent 7.

This doesn’t mean we all need to own the seven magnificent stocks. I don’t think of Tesla as a technology company with the same growth and earnings potential as, say, Microsoft or Apple. The key here is to look at the companies that still represent good value. And yes, even with high valuations, there are still companies within the Magnificent 7 that continue to be attractive. I think Google, Meta and Amazon represent good value, especially when you consider long-term growth. 

I don’t think anyone should be afraid of owning big-cap tech because these companies are ingrained in our everyday lives and in our businesses. Try to do business without Nvidia chips or Microsoft software. The world needs big-cap tech—and so do the markets. And ultimately most portfolios.

The same holds true of the broader tech sector, which makes up the largest component of the S&P 500 by far, followed by health care and financials, according to Barron’s. I think of technology as the consumer staple of today, much like food and utilities. That’s why I think many Canadian investors need to own tech stocks—along with other sectors. It’s a balance.

How to decide which sectors to buy

I’m a bottom-up stock picker. That means I look at the value of a stock, while also making sure I have holdings in different sectors to minimize the risk of, as the saying goes, putting all my eggs in one basket. So, I don’t focus on specific sectors. Whether I’m looking for protection or growth, I want to make sure I’m getting good value.

For example, to build protection into a portfolio, I look for stocks that aren’t exciting to many day traders and may not have much short-term appreciation, but are secure and typically provide a 4% to 6% dividend, such as utilities and the banks. Of course, technology can also help protect a portfolio. During COVID-19, big-cap tech performed better than the banks.

To generate strong returns, I take a sector-agnostic, growth-at-a-reasonable price (or GARP) approach and look at price-per-earnings growth, as well as how the company is positioning for future growth.

It’s important for Canadian investors to remember that even the so-called “safe” investments come with some degree of risk. Even bonds, which by industry standards are viewed as low risk, will take a hit when interest rates go up sharply—and they did. Of course, with bonds, if you hold them to maturity, you’ll get your money back.

What to look for in the S&P 500

It cannot be said enough: Diversify, diversify, diversify, and let value (growth at a reasonable price) be your guide. And that also goes for when you consider all the stocks in the S&P 500, including tech.

In my opinion, a portfolio without tech risks missing out on growth.

But it’s not all about tech. Thankfully, the markets are broadening across the board. On the Dow Jones Industrial Average, the top three performing stocks (Walmart, American Express and 3M) are enjoying double-digit growth.

So, don’t rely on any one company or sector.

Read more about investing:

• What does Nvidia’s stock split mean for Canadian investors?
• TD Bank stock: Steer clear or buy the dip?
• Making sense of the markets
• Attention, Canadian investors—the “Magnificent Seven” stocks are dominating

About Allan Small, FMA, FCSI

Allan Small is the Senior Investment Advisor at the Allan Small Financial Group with iA Private Wealth and host of The Allan Small Financial Show. He is also the author of How To Profit When Investors Are Scared. He can be reached at [email protected].

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