Goldman Sachs Warns of Earnings Bubble in Tech Sector

Goldman Sachs has released a report stating that technology stocks do not appear to be in a valuation bubble, despite rising growth expectations. However, there may be an 'earnings bubble' as investors question whether the sector's strong earnings growth can be sustained.

The report notes that while technology valuations have moderated on a price-to-earnings (P/E) basis, implied future growth has been rising. The 10-year compound annual growth rate of earnings in the tech sector has accelerated beyond the peaks seen around 2000, and forward implied growth remains well below levels seen at the peak of the dot-com era.

The report attributes this shift to a dramatic increase in capital expenditure by leading technology companies, particularly hyperscalers. This increased spending has eroded their premium cash flows and pushed them towards debt and equity markets for funding. As a result, the US equity market has seen a sharp decline in free-cash-flow yield relative to more value-orientated markets such as Europe.

Despite concerns about future returns generated by this spending, Goldman Sachs notes that prices have adjusted more modestly while earnings have remained 'exceptionally strong'. Within technology, software stocks have witnessed a particularly sharp valuation reset, with their global P/E premium falling from nearly 200% at the beginning of this century to around 20%. Meanwhile, leadership in the tech sector has shifted from software towards hardware, with memory and chip companies benefiting from explosive demand for computing capacity and strong earnings growth.