Big Tech’s ability to deliver on AI profits looms over S&P 500
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Seven firms including Nvidia and Microsoft have driven about three-quarters of the index’s gain in 2023.
PHOTO: REUTERS
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NEW YORK – The fate of the S&P 500 is increasingly resting on whether a handful of the biggest technology companies can parlay artificial intelligence (AI) investments into even higher profits.
Seven firms including Nvidia and Microsoft have driven about three-quarters of the index’s gain in 2023, in a rally stoked by an investor obsession with AI’s potential to disrupt vast parts of the economy.
Valuations are high, with the companies’ shares trading at an average of 32 times earnings.
Pressure is mounting on companies to deliver on some of the earnings hope embedded in their ever-rising stock prices.
“We’re getting closer to the moment when the companies that are claiming AI-related profits will have to start showing them,” said Mr Mark Lehmann, chief executive at JMP Securities.
“I am not calling for an expansion of multiples next year. The returns will have to come from companies actually turning in better profits.”
The companies just delivered record profits of US$99 billion (S$132.8 billion) in the third quarter. Now more is being asked of them, testament to how high the stakes have become for the stocks that have added around US$5 trillion to the market’s value in 2023.
At nearly 30 per cent of the S&P 500, they have more sway over the benchmark than ever before.
Nvidia has been the engine powering much of the group’s profit growth in 2023.
The chipmaker is projected to generate about US$28 billion in profit in 2023, up from about US$4.4 billion in 2022.
Most of the gains stem from sales of so-called accelerator chips, which are used to train the large language models that underpin applications like ChatGPT.
Others in the group have not yet shown many AI gains.
Microsoft, arguably the company in the next best position in AI owing to its US$13 billion investment in ChatGPT owner OpenAI, earned a bit less in the fiscal year ended in June than the period before.
For its next fiscal year, analysts on average expect earnings to rise 17 per cent.
Stock prices are climbing faster than earnings estimates. The average price-to-expected earnings ratio in the group of seven is up from about 21 times at the start of 2023 but below a July peak at 36.
Some, like Facebook parent Meta Platforms, are relatively cheap at 19 times. Tesla, on the other hand, is the most expensive at 63 times estimated earnings.
Some investors believe these levels may be too low.
Mr Nick Rubinstein, technology stock portfolio manager at Jennison Associates, is confident that profits from AI will help make some Big Tech stocks look like bargains at current prices.
“I’m more excited now than I have been for a very long time,” he said. “So many industries can benefit, while the arms dealers for AI should benefit even more.”
Other members of the largest seven include Apple, Amazon.com and Google parent Alphabet.
Future gains for these giants, and the S&P 500 as a whole, will hinge at least in part on the macro backdrop.
Investors are pricing in rosy scenarios, where the US avoids a recession and the United States Federal Reserve pivots from hiking rates in 2023 to cutting them as soon as the first half of 2024.
Many are reluctant to forecast that tech stocks will drop in 2024. If there is anything money managers have learnt in 2023, it is the folly of believing too strongly in year-ahead forecasts.
But even if the stocks do not fall, it is not clear how much they can rally if valuations are already so high, said Mr Phil Segner, senior research analyst and co-portfolio manager at Leuthold Group.
Nvidia’s shares have hovered in a range for most of the second half of 2023 even as profits have jumped, for example.
“To call a top in this trend has been a fool’s errand,” said Mr Segner. “I can’t say that it’s going to keep going into next year but, at some point, I think people should be aware of the risk that those stocks have in their portfolio.” BLOOMBERG
