Mag 7 Capex
Accounting is boring but important. Particularly important: the difference between a capital expense and an operating expense. A capital expense (buying a big piece of equipment, say) does not count directly against earnings on the income statement, as an operating expense (paying a salary, say) does. Instead, a capital expense appears on the income statement over time, in theory matching the drag on profits to the life of the capital asset. This spread-out expense shows up in a line called “depreciation.”
I see you sleeping at the back. But I drag you through this tiresome point because the most important companies in the world, the Magnificent 7 Big Techs, are running up a huge amount of capital expenditure, mostly on data centers for artificial intelligence. This is cash out the door today, but the expense will only appear in earnings per share over time. The AI arms race has not fully hit profits yet. The question is whether the market has digested the fact that it must do so before long.
Here is capex at the five of the seven that are, to greater or lesser extents, going bananas on capex (at Apple, capex is steady; at Nvidia, the capex money is coming in, not going out):
These are staggering numbers, and they are still growing.
Amazon looks like an outlier, but that is not quite true. One needs to scale the spending to the rest of the company’s financials. For example, one can look at capex as a percentage of revenue:
At Meta and Microsoft, one of every five dollars that comes in the door goes out as capex; at Alphabet, it is one in seven. And the trend is up (wondering about that big mountain of spending in 2022 at Meta? Remember the Metaverse?).
**Are Bankruptcies the Canary in the Coal Mine?**
Our colleague Will Schmitt pointed out yesterday that corporate bankruptcies in the US hit a 14-year high in 2024. At least 686 companies filed for bankruptcy last year, 8% above 2023’s filings and the biggest load of bankruptcies since 2010:
Is this evidence that higher rates have, at long last, come for over-indebted corporations? Or has the US economy slowed more than we have appreciated?
Of the top 10 largest bankruptcies in 2024, five were private. One, Red River Talc, is Johnson and Johnson’s holding company for baby powder liabilities. We took a look at the remaining four, and threw in two other high-profile names: home goods store Big Lots, container maker Tupperware, fabric seller Jo-Ann Stores, tinsel emporium Party City, discount air carrier Spirit Airlines, and Franchise Group, owner of retail chains such as The Vitamin Shoppe and Pet Supplies Plus.
Just a glance betrays a theme: all are discount stores, or franchises pitched to lower-income consumers. Just like the dollar stores and other discounters, many suffered as low-income Americans cut back on spending amid high inflation. One of them, Big Lots, directly blamed its downfall on this issue. Together they are an acute example of the US’s “K-shaped” recovery.
**Conclusion**
In conclusion, the market is pricing in a hot economy, and the Magnificent 7 Big Techs are running up a huge amount of capital expenditure on data centers for artificial intelligence. This is cash out the door today, but the expense will only appear in earnings per share over time. The AI arms race has not fully hit profits yet. The question is whether the market has digested the fact that it must do so before long.
**FAQs**
Q: What is the difference between a capital expense and an operating expense?
A: A capital expense does not count directly against earnings on the income statement, while an operating expense does.
Q: Why is the market pricing in a hot economy?
A: The market is pricing in a hot economy due to strong ISM services survey and Jolts report, and higher inflation break-evens and the dollar.
Q: What is the trend of capex at the Magnificent 7 Big Techs?
A: The trend is up, with capex at the five of the seven companies increasing significantly.
Q: What was the outcome of the 2024 bankruptcies?
A: The outcome was that corporate bankruptcies in the US hit a 14-year high, with 686 companies filing for bankruptcy last year, 8% above 2023’s filings.
