Goldman Sachs Warns Tech Stocks May Be in Earnings Bubble Despite Strong Growth

A recent Goldman Sachs report suggests that technology stocks are not currently 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, particularly on a price-to-earnings (P/E) basis, implied future growth has been rising. Forward implied growth remains well below levels seen at the peak of the dot-com era, even as the sector's 10-year compound annual growth rate of earnings has accelerated beyond the peaks seen around 2000.

The introduction of ChatGPT led to an 'explosion in capex' among hyperscalers, causing their premium cash flows to erode and push them towards debt and equity markets for funding. This has resulted in a sharp decline in free-cash-flow yield relative to more value-orientated markets such as Europe.

The five biggest stocks in the US now have a P/E ratio only marginally above the other 495 stocks in the S&P 500 after consistently trading at a premium since 2017. Goldman Sachs notes that this situation differs significantly from the dot-com era, where valuations reached much higher levels and subsequently declined as stock prices collapsed.

Within technology, software stocks have witnessed a particularly sharp valuation reset, with their global P/E premium falling to around 20 per cent, compared with nearly 200 per cent at the beginning of this century. Meanwhile, technology-sector leadership has shifted from software towards hardware, with memory and chip companies benefiting from explosive demand for computing capacity and strong earnings growth.