Seven tech stocks that can broaden your exposure beyond the ‘Magnificent Seven’ in 2024

The Buffalo Mid Cap Fund is rated four stars (out of five) within Morningstar’s “Mid Growth” fund category. The fund invests in companies whose market capitalizations are within the range tracked by the Russell Mid Cap Growth Index
XX:RMCCG
— from roughly $1 billion to $75 billion. West said he generally looks at companies with market caps of at least $3 billion, up to the top range of the index. The median market cap for the fund’s holdings is $18 billion and the weighted average is $28 billion he said.

“Midcaps are an interesting part of the market. You have companies that have proven out their business model but have a lot of room to run,” he said.

The fund’s midcap focus provides a broadening of exposure beyond the large-cap S&P 500
SPX,
which itself is highly concentrated in the largest U.S. companies. The SPDR S&P 500 ETF Trust
SPY
holds all 500 stocks and is designed to mirror the index’s performance. To illustrate the dominance of the Magnificent Seven — Apple Inc.
AAPL,
-0.42%,
Microsoft Corp.
MSFT,
+1.22%,
Amazon.com Inc.
AMZN,
+1.00%,
Nvidia Corp.
AMZN,
+1.00%,
Alphabet Inc.
GOOGL,
+0.30%

GOOG,
+0.25%,
Tesla Inc.
TSLA,
-0.90%
and Meta Platforms Inc.
META,
+2.60%
— the group makes up 28% of the SPY portfolio.

If we weight the Magnificent Seven by their market capitalizations at the end of last year, the group has contributed 58% of this year’s 26% total return for the S&P 500. An interesting development is that this percentage has declined from 67% as of Nov. 30. On Monday, as the three major large-cap U.S. Indexes hit 52-week highs, none of the Magnificent Seven showed gains for the day. That unusual action signaled a broadening of the U.S. stock-market rally.

Seven information providers

West said that since he became one of the Buffalo Mid Cap Fund’s managers in October 2017, he had worked to sharpen its focus on quality, which includes selecting “wide-moat, competitively advantaged companies,” with stable or improving returns on invested capital.

He also said, “we are heavily weighted toward information services companies.”

Here are the seven he discussed during the interview, with related data below:

• MSCI Inc.
  MSCI,
  -0.25%
  provides investment information to money managers and manages market indexes worldwide. The index business supports exchange-traded funds, which pay rising fees to MSCI as their assets under management increase. The fund’s various analytic services, with custom data built up over decades, are examples of the “wide moats,” or barriers to entry for competitors, that West likes to see.
• Verisk Analytics Inc.
  VRSK,
  -0.72%
  provides decision-support tools to the property and casualty insurance industry, which is in flux now as it works to balance risk and pricing in light of increasing losses from catastrophes. Wild fires in California and hurricanes in Florida are examples.
• Gartner Inc.
  IT,
  +0.65%
  offers technology-based research to companies. “They provide consulting, research and [information about] best practices,” West said. He added that corporate executives and IT professionals in particular get a lot of value from Garnet’s services. “It is as if, if Gartner recommends this, you will not get fired for doing so,” he said.
• CoStar Group Inc.
  CSGP,
  -1.46%
  provides real-estate data services, including a batch of offerings that West called “the Bloomberg for commercial real estate professionals.” This is another example of a subscription-based business to provide proprietary data that a company compiled over over decades. The company also owns Apartments.com, which provides rental listings and Homes.com, which connects home buyers directly to listing agents.
• Equifax Inc.
  EFX,
  -0.33%
  is one of the “big three” consumer credit rating agencies, competing with TransUnion
  TRU,
  +0.37%
  and Experian PLC
  EXPGY,
  +0.48%.
  Following a data breach in 2017, Equifax was forced to invest heavily in systems upgrades and security. According to West, this has helped the company “to modernize and get everything on the cloud quicker and has actually [moved] them ahead of their competitors.” He added that the investments have been starting to pay off through improved profit margins.
• Moody’s Corp.
  MCO,
  -0.02%
  is a bond ratings agency that competes with S&P Global Inc.
  SPGI,
  -0.05%.
  West estimates the two companies together handle about 99% of ratings for newly issued debt securities in the U.S. Lower volumes for new issuances have placed a drag on revenue growth, West said, but he also said that he expected volume to pick up, because “at some point you have to refinance — you cannot put it off forever.”
• IQVIA Holdings Inc.
  IQV,
  -3.25%
  has two main business lines. The company conducts outsourced studies and clinical trials for the life sciences industry. It also provides data about prescription drug sales and contact information for medical professionals to pharmaceutical sales organizations. West described this service as “a software platform for growth and data management and digital marketing.”

Returns on invested capital

One element that West cited when selecting stocks was steady or improving returns on invested capital. According to FactSet, a company’s ROIC is its profit divided by the sum of the carrying value of its common stock, preferred stock, long-term debt and capitalized lease obligations.

ROIC can vary greatly by industry. For example, auto manufacturing is a more capital-intensive business than software development, so it will tend to have lower ROIC. Comparisons of ROIC are most useful within industries and when comparing an individual company’s performance over time.

FactSet calculates ROIC by looking back over the past 12 months. Here are comparisons of the most recent ROIC calculations for the seven companies West discussed, along with lookbacks going back five years:

ROIC has improved for most of the companies, according to FactSet.

P/E ratios and growth estimates

Here are total returns for 2023 through Tuesday (with dividends reinvested), along with forward price-to-earnings ratios for the group. The table also includes expected compound annual growth rates for calendar years through 2025, based on consensus estimates among analysts polled by FactSet. Weighted numbers for the S&P 400 Midcap Index
MID
and the S&P 500 are at the bottom of the table:

The seven stocks have performed well this year and you can see that their forward P/E ratios are high relative to the indexes. West said these stocks “consistently trade at a premium to the market because of their durability of growth, high returns on capital and high free-cash-flow conversion.”

“Costar is the most expensive,” he said, “because of the large investment they are making in their Homes.com residential real estate service,” which they are building as a competitor to Zillow Group Inc.
Z,
-2.40%,
he said.

The Buffalo Mid Cap fund has returned 25.9% this year, through Dec. 19, compared with returns of 25.4% for its benchmark, the Russell Mid Cap Growth Index, and 16.5% for the S&P 400 Mid Cap Index. For five years through Tuesday, the fund returned 93.7%, compared with returns of 91.8% for the Russell Mid Cap Growth Index and 81% for the S&P 400 Mid Cap Index.

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