The S&P 500's tech sector forward price-to-earnings ratio has dropped to 21 times, matching levels seen at the time of OpenAI's ChatGPT launch. Forward earnings growth for tech has surged approximately 20% over the past three months, according to Truist's chief investment officer Keith Lerner.
TL;DR
- Tech sector valuations have dropped to levels last seen in November 2022, when OpenAI launched ChatGPT.
- Forward earnings growth for tech has increased by approximately 20% in the past three months.
- Investors are seeking proof of return on investment as major tech companies invest heavily in AI.
What happened
The S&P 500's tech sector forward price-to-earnings ratio has declined from 32 times in October 2023 to approximately 21 times, according to Keith Lerner, chief investment officer at Truist. This valuation matches levels seen when OpenAI launched ChatGPT in November 2022.
Forward earnings growth for tech has risen by approximately 20% over the past three months, Lerner noted. Despite this growth, tech valuations have compressed due to stubborn inflation and elevated Treasury yields, with the 10-year yield hovering near 5%.
Investors are demanding proof of return on investment as major tech companies like Meta and Amazon pour an estimated $800 billion into AI capital expenditures this year. This includes massive data center spending and investments in software and hardware providers.
Why it matters
For AI/ML developers and startup founders, this presents a potential opportunity to attract investment as tech valuations become more attractive. The sector's relative valuation premium has dropped to approximately 9%, near the lowest level of the past decade, according to Lerner.
Tech investors may find relative opportunities in the current market, with the sector reflecting some of the uncertainty around circular financing and the pace of new model development. Lerner suggested that underweight investors should consider adding equity exposure, with tech presenting a relative opportunity today.
However, there are still risks and open questions around the pace of new model development and potential enterprise IT budget cutbacks. Slower-than-expected monetization timelines for AI investments also pose a challenge for software and hardware providers.
Key facts
- The S&P 500's tech sector forward price-to-earnings ratio has dropped from 32 times to approximately 21 times.
- Forward earnings growth for tech has increased by approximately 20% in the past three months.
- Tech valuations are now at levels last seen in November 2022, when OpenAI launched ChatGPT.
- The tech sector's relative valuation premium has dropped to approximately 9%, near the lowest level of the past decade.
- Major tech companies like Meta and Amazon are investing an estimated $800 billion in AI capital expenditures this year.
- The 10-year Treasury yield is hovering near 5%, increasing discount rates and eroding the present value of future earnings projections.
- Investors are demanding proof of return on investment as they consider adding equity exposure to the tech sector.
Context
The current tech valuation compression is driven by stubborn inflation and elevated Treasury yields. This directly impacts the present value of future earnings projections, making tech stocks more attractive to investors seeking value.
The massive investments in AI by major tech companies highlight the sector's focus on innovation and growth. However, these investments also come with risks, including potential enterprise IT budget cutbacks and slower-than-expected monetization timelines.
For AI/ML developers and startup founders, the current market conditions present both opportunities and challenges. While the sector's relative valuation premium has dropped, there are still open questions around the pace of new model development and the proof of return on investment.