Innovation Insights: Make room Magnificent Seven. The Fourth Industrial Revolution means more mega-caps

First, Wintel. Then, the Four Horsemen. Later, FAANG. And now, the “Magnificent Seven” has us all riveted at their size, growth, and disruptiveness—from two to four to five to seven massive companies over the past two decades.¹ And we don’t think we’re done yet. The fourth industrial revolution is likely to create more half-trillion-dollar companies, and the United States is the place where it is likely to happen.

Last year was a tale of two stock markets: the Magnificent Seven and the S&P 493. The Magnificent Seven represented only 1.4% of companies in the index but contributed 70% of the S&P 500’s gains during the year. It is understandable that investors are uneasy about the narrowness of 2023’s gains. This uneasiness may not be merited. The rise of the Magnificent Seven is not as exceptional in history as it first appears, and we make the case that we will not stop at seven.

Matching one’s investing time horizon to the proper economic time horizon is essential for success. As long-term investors, then, it is logical for us first to ask where we are in the longer arc of time. Because our time horizon is over a decade, understanding the multi-decade arc is not only important but critical. In fact, it may outweigh all other considerations. Of course, the corollary is also true. An investor with a time horizon of 3–5 years, logically, should focus on the near-term business cycle. There are even investors that have time horizons of milliseconds, literally building servers and optical cables as close to exchanges as possible to gain the smallest advantages. Each approach has its merits, but, in this paper, we will focus on locating ourselves within the multi-decade arc.

Right now, we believe we are somewhere near the end of the third industrial revolution and the beginning of the fourth. The third industrial revolution started with the birth of modern-day information technology. According to scholar Klaus Schwab, the third began in the late 1960s and is called the “computer” or “digital” revolution because it was advances in semiconductors, mainframes, personal computing and the internet that propelled it forward.² These new technologies brought us companies like Microsoft, Intel, Google and Facebook. The fourth industrial revolution is the transition to the application of data in the real world, or what we like to refer to as the era of the byte, the atom and the gene.

Big, new and disruptive companies are often built on general-purpose technologies. These are new technologies or innovations that become so disruptive and pervasive in the economy that they serve as platforms for many other complementary innovations.³ Industrial revolutions are built on multiple concurrent general-purpose technologies. The third industrial revolution was ignited by the semiconductor, the internet and, somewhat separately but concurrently, biotechnology. The fourth industrial revolution, which is just beginning, is likely to be built on the gains of the third but will include new general-purpose technologies like artificial intelligence (AI), genomics and robotics. New general-purpose technologies compound the value of these previous technologies by putting to work the vast repositories of data now available to use with ease and efficiency.

In this table, the changing composition of the top 10 companies does indeed reflect the transition between industrial revolutions. Specifically, it shows that, over the last 50 years, companies that benefited from general-purpose technologies from the second industrial revolution were replaced by those founded in the third industrial revolution.

The top 10 in 1978 and 1988 are direct legacies of the second industrial revolution, which took place in the 19th and early 20th centuries. Companies like AT&T, Exxon Mobil, General Motors and Eastman Kodak are synonymous with the general-purpose technologies they were built upon, in this case telegraph and telecommunications, the combustible engine, and photography, respectively. The second industrial revolution is generally believed to span 1880–1920. Note that, in 1988, every company was founded during the second industrial revolution. This was over 100 years after its start and almost 70 years after its end. Further, not a single company in the top 10 was younger than 50 years old.

The top 10 in 1998, 2008 and 2018 signal that the status quo is changing, spurred by the third and fourth revolutions.

By the time we reach 2023, the top 10 reflects a vastly altered world. The dominant companies are those built on the general-purpose technologies of the latest revolution, and they are, not surprisingly, the Magnificent Seven, plus United Healthcare, Eli Lilly and Berkshire Hathaway. Of the 10, eight companies were founded during the third industrial revolution and are younger than 50 years old. And, of these youthful eight, the average age is 33 years, and their total value is US$12.4 trillion, or 31% of the S&P 500.⁴

That these companies are so young and so big supports our intuition that we are in the middle of a new revolution.

In fact, the rise of the Magnificent Seven isn’t really a strong surprise to us because it’s what Carlota Perez, a prominent academic who has studied industrial revolutions and has written one of the leading books on the topic, Technological Revolutions and Financial Capital, might have predicted.⁵ In her model, economic revolutions start with new disruptors (usually small, young companies) that introduce innovation—usually general-purpose technologies, though she doesn’t call them that—to the world. Once investors catch onto the power of the innovation, dollars start chasing these smaller companies, effectively lowering their cost of capital relative to older incumbents. With the wind at their sails, these upstarts quickly grow larger and more dominant than the incumbents and become the latest monopolists. Until the whole cycle starts again. This is the “creative destruction” of capitalism at work.

Perhaps scholar Hendrik Bessembinder would also have predicted this. He found that the best-performing 4% of listed companies were responsible for the entire US stock market gains since 1926.⁶ In other words, a narrow market is not historically unique. And it is certainly true of the Magnificent Seven that they are the most successful firms today—excluding Tesla, earnings for the other six companies are projected to jump 62.8% in the fourth quarter of 2023 versus an 8.6% decline for the rest of the S&P 500.⁷

We believe that the rise of the Magnificent Seven is another marker that we are going through a period of massive economic change. We are not at the end of that change but rather in the middle of it. Currently, we can see the third industrial revolution laying down the foundational general-purpose technologies that will aid the fourth. That we can spot several potential general-purpose technologies—starting with AI today and potentially expanding to include genomics, electrification and robotics—gives us further confidence in this view. These emerging innovations suggest to us that this next era may produce more new compa­nies that will use these new technologies to solve hard problems in all different corners of the economy. Under these auspices, we find it increasingly likely that the ranks of the Magnificent Seven will grow larger. And our focus remains on separating what is durable and revolutionary from what is merely short-term noise, so that we get right the multi-decade arc that is the fourth industrial revolution.