Barclays Warns of Potential Downturn in Earnings Growth as Big Tech Ramps Up Capex for AI Investments
In a recent note, Barclays strategists have raised concerns about the increasing capital expenditures (capex) among Big Tech companies, signaling a potential downturn in earnings growth. The investment bank notes that the industry is currently experiencing the highest capex-to-sales ratio in a decade, driven by investments in AI technology. While AI offers significant growth potential, it also comes with a level of uncertainty.
Barclays highlights that the market is anticipating high teens to low twenties percentage growth in earnings per share (EPS) for the next year. However, the expanded cost base from the AI buildout may pose challenges for more established segments of these businesses as they transition past the high-growth phase from the second half of 2023 to the first half of 2024.
The strategists point out that capex spikes in 2018 and 2022 were precursors to negative earnings cyclicality as growth tapered off. They also note that analyst estimate dispersion signals higher uncertainty for Big Tech compared to the rest of the S&P 500 over the next two quarters.
Barclays suggests that the increased capital intensiveness, potential earnings growth cyclicality, and a stricter regulatory environment could pose downside risks to Big Tech valuations. Historically, during similar phases, the next twelve months price-to-earnings (NTM P/E) ratios for these companies have dropped to the low-to-mid 20s.
While Barclays believes that Big Tech could still perform well in the event of a soft landing for the economy, caution is advised at the higher end of the sector's trailing twelve-month valuation range. The report also indicates that the cyclicality of the market could benefit other segments of the S&P 500 in the short term.
Sectors like Consumer Services, which have historically seen earnings growth trough later and recover more slowly than Big Tech, are expected to be well-positioned through the end of the year. The firm's analysis of earnings growth momentum and NTM P/E multiples supports this view, suggesting a favorable outlook for service-oriented stocks.
In conclusion, investors should be mindful of the potential risks associated with the increasing capex among Big Tech companies and the implications it may have on their earnings growth and valuations. Diversifying investments across different sectors, such as Consumer Services, could provide a hedge against the cyclicality of the market and offer opportunities for growth in the short term.
