Alongside artificial intelligence (AI), one of the defining market drivers in 2024 has been the outperformance of companies exhibiting positive operating leverage. This dynamic is especially evident among the “Magnificent Seven” stocks—Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, and Tesla—all of which have harnessed scalable business models to thrive in a complicated economic environment. With Trump’s tariff-focused policies looming, this trend appears poised to continue, with the potential for sectors like banks and industrials to also benefit. We believe companies with positive operating leverage will continue to be rewarded.
The Power of Economies of Scale
Positive operating leverage occurs when a company's revenue grows faster than its fixed and variable costs combined, resulting in operating income (or profit) growing at a faster rate than revenue. This creates margin expansion and improves profitability at an accelerated rate compared to revenue growth. It is most prominent in industries with high fixed costs and scalable models, such as technology.
For example, companies like Nvidia and Meta have made significant up-front investments in research and development (R&D) and infrastructure. However, as revenues grow—whether through AI chip sales for Nvidia or digital ad revenue for Meta—the incremental costs to serve additional customers are minimal. The result? Higher operating margins and increased earnings power.
Economic Backdrop: Favorable Conditions for Operating Leverage
The 2024 economic environment amplified the value of positive operating leverage for several reasons:
Slowing Inflation with Higher Comps Ahead
Inflation remains above the Federal Reserve’s target but has moderated significantly from its peak in 2022-2023. Importantly, inflation comparisons (“comps”) are set to become tougher in 2025 as the base effects of prior high inflation fade. For companies with positive operating leverage, this environment is favorable: they can pass through some cost increases to customers without eroding margins, ensuring profitability outpaces revenue growth. Their economies of scale also enables them to withstand minor accelerations in input cost growth without major disruptions to operations.
A Resilient but Balanced Job Market
The labor market has stayed strong but has not overheated, providing a stable consumer backdrop without significant wage pressures. This stability benefits technology companies, which depend on consumer spending and corporate investment. For example, Amazon capitalized on its positive operating leverage in its retail and cloud businesses as wage pressures eased but consumer demand remained resilient.
Federal Reserve Rate Cuts
The Federal Reserve’s recent shift to cutting interest rates is another tailwind. Lower borrowing costs reduce the hurdle rate for capital investment, particularly for tech companies with robust R&D pipelines. Additionally, rate cuts support valuation multiples for growth stocks, which are particularly sensitive to interest rates due to their long-duration cash flows.
Trump’s Tariff Policies: A Mixed Bag
Trump’s renewed focus on tariffs could create headwinds for global supply chains, particularly in manufacturing. However, companies with positive operating leverage—especially the Magnificent Seven—may emerge as relative winners for three reasons:
Tech’s Supply Chain Diversification
Many tech companies have already diversified supply chains away from China, reducing their vulnerability to new tariffs. Apple, for instance, has increased production capacity in India and Vietnam, mitigating the impact of potential tariff hikes.
Pricing Power
Companies with dominant market positions (e.g., Nvidia in AI chips or Microsoft in productivity software) can pass on higher costs to consumers with minimal demand impact. This pricing power supports the revenue growth necessary to sustain positive operating leverage.
Domestic Growth Opportunities
Tariffs often incentivize globalized companies to prioritize domestic markets. With Trump likely to push policies favoring U.S. manufacturing and innovation, companies like Tesla stand to benefit from renewed federal incentives for electric vehicles and infrastructure investment.
What’s Next?
The conditions that have rewarded positive operating leverage in 2024 are likely to persist, albeit with potential challenges. Sophisticated investors should monitor key risks, such as any reversal in the Federal Reserve’s generally dovish stance or a significant downturn in consumer demand. However, the structural advantages of the Magnificent Seven’s business models—scalability, pricing power, and innovation—leave them in a position of strength.
As we head into 2025, investors should consider maintaining exposure to companies with positive operating leverage, especially in technology. The Roundhill Magnificent Seven ETF ($MAGS) offers a targeted way to capture this trend, providing access to companies driving market leadership in the face of changing economic and political dynamics.
Investors should consider the investment objectives, risk, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about Roundhill ETFs please call 1-855-561-5728 or visit the website at www.roundhillinvestments.com/etf/MAGS. Read the prospectus or summary prospectus carefully before investing.
Investing involves risk, including possible loss of principal. The Fund expects to have concentrated (i.e., invest more than 25% of its net assets) investment exposure in one or more of the Technology Industries at any given time, which may vary over time. Further, the Fund expects to obtain such investment exposure by transacting primarily with a limited number of financial intermediaries conducting business in the same industry or group of related industries. As a result, the Fund is more vulnerable to adverse market, economic, regulatory, political or other developments affecting those industries or groups of related industries than a fund that invests its assets in a more diversified manner. The value of stocks of information technology companies and companies that rely heavily on technology is particularly vulnerable to rapid changes in technology product cycles. Please see the summary and full prospectuses for a more complete description of these and other risks of the Fund.
Roundhill Financial Inc. serves as the investment advisor. The Funds are distributed by Foreside Fund Services, LLC which is not affiliated with Roundhill Financial Inc., U.S. Bank, or any of their affiliates.
