The Year of Efficiency

Charted below are the market cap-weighted top ten largest S&P 500 companies, the plain Jane S&P 500, and the equal-weighted S&P 500, which reduces the weight of the top ten from over 30% to a mere 10ish%.

As you can see, these top ten largest companies, which include Apple, Amazon, Google, Meta Platforms, Microsoft, Nvidia, Berkshire Hathaway, Tesla, and Eli Lilly, have absolutely dominated the rest of the market year-to-date.

I wanted to use this week's post to discuss how these companies are hyper-efficient at producing growth and cash flows, much like few other companies before.

Starting with advertising, Microsoft, Google, Meta, and Amazon all have a role to play in it.

Newspapers used to be a goldmine. You would print words on a sheet of paper, deliver it to homes, and place advertisements throughout. Newspaper companies got paid by both the customers who ordered them and the businesses who advertised in them. All they had to do was get it to your door.

Small newspapers sometimes had 50-60% profit margins because of this.

Now, imagine you have no delivery or print services; all you do is sit back and watch it come in. That is Google. That is Meta. That is Amazon. And to some degree, that is Microsoft.

Every time you click around in the Google ecosystem, whether it's in Gmail, YouTube, or the standard browser, Google is showing you ads. The longer you stay, the more they make, at no cost to you.

Microsoft Bing is very similar.

Most of us probably have a Facebook, Instagram, WhatsApp, Threads, etc. account, and every time you use those services, you are being shown ads, sometimes to the extent that every three posts, an ad is served.

When you shop on Amazon, the top ten listings are usually ads, and when you click, Amazon makes money.

Even better, the longer you stay, the better they get at serving you ads, making you click more, and companies will pay extra to get their ads shown to people who may be interested in what they are selling.

It's software, low cost, easy to maintain, and not capital-intensive, all of which translates to very high profit margins, just like newspapers back in the day.

Then you have the hardware where these things are hosted: Apple, Microsoft, Nvidia, Google, and to some extent, Tesla and Meta.

Hardware is where the ads are shown. When you open the Facebook app on your phone and click on an ad, Apple makes 30% of that click, and Facebook gets the rest. The same applies to Gmail, YouTube, and I believe the Google app.

Warren Buffett famously said, "When given the choice between never owning an iPhone again to get $10,000 and being able to own an iPhone, most people would choose the latter." This would include myself; the trade-off just wouldn't be worth it.

Apple created one of the greatest personal computers ever. To the extent that Google pays Apple billions of dollars to be a default search engine option on Apple's Safari browser. All Apple has to do is exist and sell iPhones to rake in money.

Having a great product where all of the high-profit margin software can exist is incredibly valuable, something ordinary consumer products can't do.

Moving on to components, whenever you open Gmail, YouTube, Google, Netflix, Apple News, you are streaming information from a data center (the Cloud). Increasingly, those data centers are using Nvidia GPU processors and processing systems to operate. Now with AI, that is increasing exponentially.

And just so I touch on all the companies I listed for this product section, Tesla is increasingly becoming the Apple of cars. The software component of Tesla is very large, larger than ordinary car companies.

Microsoft's personal computing is fairly obvious with the number of computers created by Microsoft, but also because of the software package that comes with them, Office.

Meta is competing with Apple on spatial computing, which I believe can be an incredible opportunity.

And Google owns the Android ecosystem.

Owning the hardware is incredibly valuable.

Owning the software is also incredibly valuable.

Owning both is obviously better, which many do too.

So you can hopefully see just how efficient these companies are at existing together and efficient at producing cash flow.

Within Google, Meta, Amazon, it doesn't matter where you are; they are getting a cut.

And because they are getting a cut and exist on Apple's and Google's hardware platform, Apple and Google get a cut along with producing fantastic consumer products.

Because all of this takes incredible computing power, the companies that power the Cloud and the Digital Infrastructure of the world get a cut.

I titled this the year of efficiency because these companies have proven that they can exist and produce high margins and cash flows in zero-interest-rate environments and high-interest-rate environments, something that very few can predictably do.

It's also what Meta Platforms titled its year at the beginning of the year.

After all of this, is it really that shocking that these companies are worth as much as they are?