Big tech earnings growth facing downside risks, Barclays says

Investing.com — The increasing capital expenditures (capex) among Big Tech companies could signal a potential downturn in earnings growth, Barclays strategists cautioned in a Tuesday note.

According to the investment bank, the industry is experiencing the highest capex-to-sales ratio in a decade, driven by investments in AI technology. While AI offers substantial potential for growth, it also presents a notable level of uncertainty.

Barclays notes that the market currently anticipates 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 the more established segments of these businesses as they move past the high-growth phase spanning the second half of 2023 to the first half of 2024.

“CapEx spiked two other times in the last decade – 2018 and 2022 – both were preludes to negative earnings cyclicality as growth rolled off the peak,” Barclays strategists wrote.

“Analyst estimate dispersion signals higher uncertainty for Big Tech vs. the rest of SPX (S&P 500) over the next 2 quarters,” they added.

As such, the increased capital intensiveness, alongside potential earnings growth cyclicality and a stricter regulatory environment, adds downside risks to Big Tech valuations, according to Barclays.

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.

“The de-rating in Big Tech shares was notably more severe than for the rest of the in both instances,” the note highlights.

While Barclays maintains that Big Tech could still fare well if the economy experiences a soft landing, caution is advised at the higher end of the sector’s trailing twelve-month valuation range.

Meanwhile, the report 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 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.