Tesla's Q3 Earnings Were Great, But They Were Not Great Enough To Keep Its 'Mag Seven' Membership?

Despite Tesla's impressive Q3 earnings report last week, which led to a whopping 22% surge on Thursday, marking the best single-day performance in 11 years, the market is now returning to rationality as Wall Street assesses whether the stock should be included in the "Mag Seven".

The current members of the "Mag Seven" include NVIDIA, Apple, Alphabet, Amazon, Meta, Microsoft, and Tesla. They have long been the dominant forces in the U.S. stock market.

As the Q3 earnings season arrives, the "Mag Seven" is once again becoming a potential key drivers. According to FactSet, these seven companies are expected to lead the market with a year-over-year growth rate of 18.1% in the third quarter, with four of them—NVIDIA, Alphabet, Amazon, and Meta—expected to be among the top 10 stocks contributing to the earnings growth of the S&P 500.

Despite Tesla's earnings rebound in the third quarter, concerns continue to grow, and the debate around Tesla is flaring up again. Tesla's third-quarter profit soared by 17%, achieving a dramatic reversal after two consecutive quarters of decline. But this seems far from enough for Wall Street.

Wall Street strategists believe that due to the overhyped fundamentals, the stock still runs the risk of lagging behind other large-cap tech stocks.

Jay Woods, Chief Global Strategist at Freedom Capital Markets, the investment banking division of Prime Executions, Inc., compared Tesla to Bitcoin, implying that Tesla's stock trading is more based on hope and dreams rather than fundamentals.

He warned, "Tesla had its moment in the sun ... to me, it's more like a Cisco or an Intel during the dot-com bubble, and now we're moving on to other things."

Although CEO Elon Musk often classifies Tesla as a technology company, the company's bets on artificial intelligence and robotics may take years to pay off. In the meantime, Tesla must rely on improving its core automotive business, which is in stark contrast to other members of the Mag Seven.

Long-term tech stock investor Dan Morgan said, "I've been in the tech sector since 1990, and I remember the Four Horsemen ... We didn't add an auto stock with Cisco, Intel, Dell, and Microsoft."

Tesla's recent poor performance and high valuation further weakened its position among the seven giants. Data shows that the company's expected price-to-earnings ratio is close to 73 times, far exceeding other members of the Mag Seven.

Furthermore, as of last Friday afternoon, only over 40% of analysts studying Tesla rated the stock as buy, making Tesla the least favored stock among the seven giants by analysts.

Who Will Be Tesla's Replacement?

Wall Street seems to have reached a consensus on Tesla's replacement: Netflix has become a strong contender.

Wealth Enhancement Group analyst Ayako Yoshioka pointed out that Netflix makes the most sense because the company's stock recently hit a historical high driven by strong earnings and solid guidance. Since the beginning of this year, the stock has risen by 61.08%, second only to NVIDIA and Meta.

Jesus Alvarado-Martinez of Portfolio Wealth Advisors also said that being one of the seven giants means being a cash flow machine, and Netflix fits the bill.

Since the COVID outbreak, the company's free cash flow has been steadily climbing, reaching $2.19 billion in the third quarter, up from $1.89 billion in the same period last year. In 2023, its total free cash flow was $6.93 billion, compared to $1.62 billion in 2022.

Bank of America analyst Jessica Reif Ehrlich also believes that Netflix's growing free cash flow is the catalyst for the stock's rise and expects its free cash flow to rise to $8.9 billion by 2025 and $11.16 billion by 2026.

Data shows that as of last Friday, analysts were overwhelmingly optimistic about Netflix, with 87% rating it as a buy and only 3% advising to sell.