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.
Technology stocks do not appear to be in a valuation bubble despite rising growth expectations, but there could be an "earnings bubble" as investors question whether the sector's strong earnings growth can be sustained, according to a Goldman Sachs report.
"Across Technology, there does not appear to be a valuation bubble, but there may be an earnings bubble. Investors have reflected these concerns and there is Value that is emerging," Goldman Sachs Global Investment Research said in its Global Strategy Views report.
The report noted that while technology valuations have moderated, particularly on a price-to-earnings (P/E) basis, implied future growth has been rising. However, 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 shift comes amid a dramatic increase in capital expenditure by leading technology companies. Goldman Sachs said that for about a decade after the global financial crisis, major technology companies benefited from rising demand for software and cloud computing while remaining relatively capital-light.
However, the introduction of ChatGPT was followed by an "explosion in capex" among hyperscalers. The increased spending has eroded their premium cash flows and pushed them towards debt and equity markets for funding, according to the report.
It added that the US equity market, which is dominated by hyperscalers, has consequently seen a sharp decline in free-cash-flow yield relative to more value-orientated markets such as Europe. Concerns about the future returns generated by this spending have also resulted in a de-rating of dominant technology companies.
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, however, said the current situation differs significantly from the dot-com era. During that period, valuations reached much higher levels and subsequently declined as stock prices collapsed. This time, prices have adjusted more modestly while earnings have remained "exceptionally strong".
Within technology, software stocks have witnessed a particularly sharp valuation reset. Their global P/E premium has fallen 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.
Despite this earnings growth, Goldman Sachs noted that the cyclical nature of hardware and chip businesses and concerns over whether their earnings are sustainable have also led these stocks to de-rate.
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