For the past decade, the list of the largest publicly traded U.S. companies has consistently been dominated by many of the same technology firms. These have become the hallmark of our country’s innovative culture, with their products and services working their way into almost every facet of our lives. This is especially true for many people living in the Bay Area where these organizations double as our neighbors and possibly employers, and which are often responsible for the majority of many people’s net worth. Yet, as successful and beloved as they might be, it is our job to continually question whether they will maintain their dominance, and to also be skeptical about whether they still represent rewarding investments going forward. This is all amplified as the impact of the inevitable next wave of technological innovation unfolds.

On the surface, the largest technology companies currently appear to be holding their own as they have demonstrated their willingness, and ability, to outspend everyone else in the race to build artificial intelligence infrastructure. Indeed, the spending from Amazon, Meta, Microsoft and Alphabet over the last year has grown so much that it represented a quarter of the capital expenditure (capex) and research and development (R&D) spending for all the companies in the S&P 500 combined. While this seems excessive, it’s important to remember that during the height of the tech bubble in the late 1990s, publicly traded technology, media and telecom companies were collectively spending more than 100% of their cash flow from operations on capex and R&D. As of July, the total is just over 70%, according to Goldman Sachs. Furthermore, given the significant growth of many companies over the last decade, their financial health and ability to spend has become a distinct competitive advantage.

Yet, an interesting dynamic is now developing—companies that were historically lauded for their capital-light, highly profitable business models are becoming increasingly capital-heavy. Over the last several months, investors have started questioning this strategy since most companies have not demonstrated any meaningful return on these new investments thus far. Of course, one argument is that it is still very early; and as Alphabet’s CEO said during July’s earning call, the “risk of underinvesting is dramatically greater than the risk of overinvesting.” This may ultimately end up being true, but historically, the companies that built the infrastructure that supported technological change were not always the largest beneficiaries. 

Even more fascinating is the evolving nature of the investments that are being made. Spending on powerful chips is a given at this stage and companies such as NVIDIA are the primary beneficiaries. However, many old-world industries are also benefiting from investments coming their way. Microsoft recently announced that it has signed a deal with the owner of Three Mile Island—the infamously shuttered nuclear power plant that failed in the 1970s. The company has agreed to purchase the plant’s entire electric-generating capacity over the next 20 years, and rather than using the output to power an estimated 800,000 homes annually, it will instead all go to powering energy-hungry data centers. Microsoft isn’t alone in its quest to combat the physical constraint that the need for electricity is presenting. Earlier this year, Amazon purchased a data center site next to the Susquehanna nuclear power plant and recently announced that it had made a $500 million investment in X-energy, a nuclear reactor and fuel technology company. As the demand for electricity grows, many industries stand to be big beneficiaries, and this may blur the lines between traditional growth and value sectors.

In our view, a big lingering question will be how investors choose to value companies that are shifting away from their capital-light business models. Wall Street will generally pay a higher valuation multiple for companies that are scalable, but if future growth comes with an increasingly large price tag, multiples may fall. Furthermore, a more diverse set of industries stands to benefit from the growth of electrification, and this may provide competition for investment dollars. As of mid-October, the stocks in the utilities sector were in the aggregate up more than 30% for the year-to-date period, which is almost in-line with the return of the broader technology sector. This broadening of participation in the stock market rally is good news as mega-cap technology stocks are trading at valuation levels that are high when compared to their historical averages and may not fuel continued stock market appreciation. The stock market isn’t always a good barometer for the broader economy, but in this case, capex dollars that support more industries should also support the economy and job market.

As the Federal Reserve continues to lower interest rates, this too should provide support for a broader range of industries, including many small companies that have historically needed access to capital. Indeed, during the third quarter of this year, small and mid-cap stocks outperformed large-cap stocks as investors anticipated the Federal Reserve’s first interest rate cut. This is a marked change from the trend we saw over the previous two and half years when investors heavily favored cash-rich larger companies that didn’t need access to capital.

These themes are very supportive of a diversified investment strategy that isn’t overly exposed to the mega-cap technology companies that we have all grown to love. Throughout this year, our clients’ portfolios have held an overweight to small and mid-sized companies as we felt that they were poised to outperform as interest rates came down. We have begun to see this happen and we expect it could continue given their exposure to the domestic economy and their undervalued pricing when compared to historical averages.

The IPO market has almost been closed for business over the last several years. As interest rates come down and investors’ appetite for companies that still need access to capital increases, we may see this change. According to Crunchbase, as of May, there are over 700 U.S.-based private, venture-backed companies with valuations at—or above—one billion dollars. Many of these companies will probably choose to stay private but this may change if public markets become more amenable to newly public companies. This would not only be a huge positive for the venture and private equity industries where exit strategies have been quite limited over the last several years, but also give public market investors some welcome fresh ideas to consider. This could result in money flowing out of mega-cap technology companies as investors focus on companies with potentially larger growth opportunities.

Of course, we have no doubt that in the shorter term, many of the popular mega-cap technology companies will continue to thrive and dominate their respective industries. In our view, though, it is equally important to consider the longer-term horizon as well, and we may eventually discover that they are not as dominant during this new wave of technological innovation as they were during the last one. We plan to continue managing diversified asset allocations and believe that this strategy will lead to better long-term outcomes than simply being overexposed to the winners from the last technology cycle.