AI Stock Risk Is in Earnings, Not Valuations, Goldman Sachs Says

The key risk for high-flying technology stocks lies not in overstretched valuations but in the durability of their explosive profit growth, according to a new analysis from Goldman Sachs. Strategists at the bank suggest that while stock prices have moderated, the market may be pricing in an unsustainable level of future earnings, creating a potential "earnings bubble."

Valuations Have Normalized

In a note to clients, strategists led by Peter Oppenheimer observed a significant shift in market dynamics, with leadership broadening beyond the largest U.S. technology names. They point out that the once-steep valuation premium for the top five U.S. stocks has "almost disappeared," with their forward price-to-earnings (P/E) ratios now only marginally above the rest of the S&P 500.

This marks a stark contrast to the dot-com era, the report notes. While dot-com valuations collapsed as stock prices plummeted, the recent adjustment has been more modest in price terms, supported by "exceptionally strong" earnings. Software stocks in particular have seen a steep de-rating, with their global P/E premium falling to around 20%, a fraction of the nearly 200% premium seen at the turn of the century.

The 'Earnings Bubble' Thesis

Despite this valuation compression, implied expectations for future profit growth have continued to climb to historic levels. Goldman's analysis, using a one-stage dividend discount model, found that the implied 10-year earnings compound annual growth rate (CAGR) for the tech sector has "accelerated well beyond the 2000 peaks."

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This divergence is the foundation of the bank's warning. "Across Technology, there does not appear to be a valuation bubble, but there may be an earnings bubble," the strategists wrote. They attribute part of the valuation moderation to a surge in capital spending by hyperscalers since the advent of generative AI, which has eroded free cash flow and pushed companies to raise funds through debt and equity.

A Broader Market Shift

Goldman Sachs also highlights a burgeoning "capex super cycle" that is extending beyond technology into "old economy" sectors. This has boosted the prospects of previously overlooked industries, with Industrials now carrying the highest sector valuation globally, trading above their 20-year range.

The bank views the broader market participation and falling stock correlations as a "healthy normalization" after years of extreme concentration. This environment, where sectors like Energy have seen strong performance despite weaker earnings growth, is creating "alpha opportunities" for selective investors who can identify companies with durable growth prospects.