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Big Tech’s Ability to Deliver on Ai Profits Looms Over the S&P 500

December 10, 2023
minute read


The trajectory of the S&P 500 is increasingly contingent on whether a handful of major technology companies can leverage their investments in artificial intelligence (AI) to generate even greater profits. Seven companies, including Microsoft Corp. and Nvidia Corp., have been responsible for about 75% of the index's gains this year, as investors are captivated by AI's potential to disrupt various sectors of the economy. These companies, however, face high valuations, with their shares trading at an average of 32 times earnings. The market is now scrutinizing these firms to deliver on the earnings expectations embedded in their soaring stock prices.

Mark Lehmann, CEO at JMP Securities, notes that companies emphasizing AI-related profits will soon need to demonstrate tangible results. He anticipates a shift from relying on expanding multiples to actual improvements in profits. Despite the seven companies posting record profits of $99 billion in the third quarter, expectations are escalating, underscoring the significance of these stocks, which have collectively added approximately $5 trillion to the market's value this year. Representing nearly 30% of the S&P 500, they wield more influence over the benchmark than ever before.

Nvidia Corp. has played a pivotal role in driving the group's profit growth this year, with its substantial earnings increase attributed to the demand for AI. The chipmaker is projected to achieve around $28 billion in profit this year, a significant surge from about $4.4 billion in the previous year. Most of these gains stem from the sales of accelerator chips crucial for training large-language models like those supporting applications such as ChatGPT.

While Nvidia has seen notable AI-related gains, other members of the group, such as Microsoft, have yet to exhibit similar advancements. Microsoft, with a substantial investment in OpenAI, the owner of ChatGPT, reported slightly lower earnings in the fiscal year ending in June than the previous period. Analysts expect a 17% increase in earnings for the next fiscal year.

Despite these encouraging profit figures, stock prices are outpacing earnings estimates. The average price-to-expected earnings ratio for the group of seven has increased from around 21 times at the beginning of the year, peaking at 36 in July and currently sitting below that peak. Some companies, like Meta Platforms, are relatively cheap at 19 times, while Tesla is the most expensive at 63 times estimated earnings.

Nick Rubinstein, technology stock portfolio manager at Jennison Associates, believes that AI-driven profits will eventually make Big Tech stocks appear undervalued at current prices. He sees widespread benefits across industries and expects AI "arms dealers" to benefit even more.

However, uncertainties loom regarding how much these stocks can rally further, given their already high valuations. Phil Segner, senior research analyst and co-portfolio manager at Leuthold Group, suggests that even if the stocks don't experience a decline, their potential for significant gains may be limited. Nvidia's shares, for instance, have remained within a range for much of the second half of 2023 despite substantial profit increases.

While many investors hesitate to predict a decline in tech stocks next year, there is growing awareness of the risks associated with holding stocks that already command high valuations. The prevailing macroeconomic backdrop, including the avoidance of a U.S. recession and potential shifts in Federal Reserve interest rate policies, will play a pivotal role in determining the future gains of these tech giants and the overall S&P 500.

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Eric Ng
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Eric Ng
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John Liu
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