Barclays Warns of Potential Big Tech Earnings Slowdown Amid High Capex

The increasing capital expenditures (capex) among Big Tech firms could indicate a potential slowdown in earnings growth, Barclays strategists warned in a Tuesday note. The sector is experiencing its highest capex-to-sales ratio in a decade, driven primarily by investments in artificial intelligence (AI).

While AI offers growth potential, it also introduces uncertainty. Barclays noted that the market anticipates earnings per share (EPS) growth in the high teens to low twenties percentage range for the upcoming year. However, costs associated with AI investments could challenge the established segments of these companies as they move past their peak growth phase between the second half of 2023 and the first half of 2024.

Barclays' Caution on Earnings Cyclicality

“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.

The firm pointed out that analyst estimate dispersion indicates higher uncertainty for Big Tech compared to the broader S&P 500 over the next two quarters. Increased capital intensity, potential earnings cyclicality, and a stricter regulatory environment are contributing factors to the downside risks for Big Tech valuations.

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 range. “The de-rating in Big Tech shares was notably more severe than for the rest of the S&P 500 in both instances,” the note highlighted.

Potential Market Shifts and Opportunities

Despite this, Barclays maintains that Big Tech could still perform well if the economy achieves a soft landing, although caution is recommended when valuations are at the higher end of the sector's trailing twelve-month range.

Meanwhile, Barclays suggests that other segments of the S&P 500 could benefit from market cyclicality. Sectors such as Consumer Services, which have seen slower earnings recovery 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 a favorable outlook for service-oriented stocks.