Goldman Sachs has issued a warning that the artificial intelligence (AI) investment boom is helping to drive corporate profitability in the S&P 500 to record highs, but the massive spending fueling this surge could ultimately suppress the investment returns of major technology companies.
In a report published on June 12, Goldman Sachs strategist Ben Snider noted that record corporate profitability has become a crucial pillar supporting the high valuations in the U.S. stock market. Currently, the forward price-to-earnings (P/E) ratio for the S&P 500 is approximately 21, placing it in the 87th percentile of its historical distribution since 1980. Concurrently, the return on equity (ROE) has climbed to a record 22%.
Corporate Earnings Drive Market Gains
The report points out that despite a contraction in valuation multiples, the S&P 500 has risen 9% year-to-date. The primary force behind this market advance has been earnings growth. Consensus estimates for earnings over the next 12 months have increased by 17%, while the forward P/E ratio has contracted from 22 to 21 over the same period.
Goldman Sachs estimates that a 1-percentage-point change in the S&P 500's ROE typically corresponds to a change of about 1 multiple in the market's P/E ratio, underscoring the importance of profitability for future stock market returns.
The recent significant improvement in profitability has largely stemmed from margin expansion, particularly among large technology firms. Goldman estimates that the seven largest tech giants, including NVIDIA (NASDAQ: NVDA), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOGL), Amazon.com (NASDAQ: AMZN), Meta Platforms, Inc. (NASDAQ: META), Apple (NASDAQ: AAPL), and Broadcom (NASDAQ: AVGO), currently achieve a combined ROE of 44%, which is 9 percentage points higher than three years ago.
Winners and Losers in the AI Race
The report highlights a growing divergence within the AI infrastructure build-out, between semiconductor manufacturers and the cloud computing giants funding the construction. Chipmakers are among the biggest beneficiaries of the AI spending boom. Strong demand coupled with supply constraints has pushed their profitability to historic highs. Goldman notes that the net profit margin for the semiconductor sector is nearing 50%, primarily benefiting from strong pricing power and solid competitive advantages.
In contrast, hyperscale cloud service providers are bearing the substantial costs of the AI infrastructure race. Goldman Sachs forecasts that capital expenditures for major cloud operators will reach approximately $770 billion by 2026, equivalent to about 100% of their operating cash flow. This spending is reshaping their financial structures. As companies continue to build data centers, asset turnover has declined; depreciation expenses are rising; and some firms are raising investment funds by increasing debt and issuing new equity.
Goldman expects the depreciation and amortization expense as a percentage of revenue for hyperscalers to rise from 7% in 2022 to 12% by 2027. Consequently, consensus estimates indicate that the ROE of the largest tech companies will decline by an average of 7 percentage points next year. According to the report, Apple is projected to see the largest decline in ROE, followed by NVIDIA, Alphabet, and Meta Platforms, Inc..
AI Remains a Long-Term Bet
Despite near-term pressures, Goldman Sachs does not view the AI spending cycle as purely negative for profitability. The bank points to improving revenue expectations, increasing customer order backlogs, and margin expansion for major cloud providers as signs that AI investments are beginning to yield returns.
Goldman analysts also anticipate that the economics of AI models will improve further as the computational cost per token continues to decline while pricing stabilizes. For the broader economy, the bank believes AI-driven productivity gains could become a significant source of long-term profit growth. Recent earnings calls show that over half of S&P 500 companies have mentioned productivity improvement plans related to AI, though only a few have quantified the financial impact so far. Goldman expects that as AI adoption spreads, overall corporate revenues and profit per employee in the U.S. will ultimately increase.
Valuations Hinge on Profitability
For investors, the central question is whether the current record-high profitability can be sustained. Goldman Sachs believes the future trajectory of stock market valuations will largely depend on whether corporate returns can be maintained near current levels.
While AI infrastructure investment may pressure the profitability of large tech companies in the short term, the bank believes that the broader productivity gains from AI could eventually offset some of the negative impact. For now, record profitability remains one of the strongest justifications for the U.S. stock market continuing to trade well above its historical valuation levels.
Comments