Just 10 AI, Tech Firms Produce Two-Thirds Corporate Profit Growth

After Friday's market meltdown, which

was sparked by growing concerns about the reliability of AI projections, as well as the news that Google's search business was under attack - from its own AI service - there has, again been increasing attention on the issue of earnings concentration.

But investors seem to believe that risk is priced into the market already and that it is no longer a stealth or surprise threat. The larger question remains whether AI's financial and operational benefits can break out across the economy at scale. JL

Hannah Lang reports in the Wall Street Journal:

The boom is being driven by just 10 companies which account for two thirds of corporate profit growth. Micron and Nvidia alone account for a third of the earnings growth. If you take out those 10 all stars, the earnings growth for the S&P 500 for the third quarter drops from 30% to 10%. This is just one more way in which the stock market has come to depend heavily on the massive bet on AI; that the productivity gains and money-making ability of AI will be worth the hundreds of billions of dollars being spent. As soon as Wall Street starts to question that belief it can lead to violent shifts in the market. So the risk posed by concentrated earnings growth is the same risk underpinning the broader AI investing boom, that the technology won't be able to deliver on the massive sums US companies are pouring into it. "The fear is we're going to end up converting all these data centers into pickleball facilities."

 It's earning season and Wall Street is feeling optimistic. According to FactSet, S&P 500 third quarter earnings are expected to rise 30% year over year, but there's a catch. The boom is being driven by just a handful of AI giants. Just 10 companies account for roughly two thirds of corporate profit growth according to a Dow Jones market data analysis. But how long can they keep it up? WSJ reporter Hannah Erin Lang joins us now to break down this concentration in corporate earnings and what it could mean for the market going forward. Hannah, which companies are we talking about here?

Hannah Erin Lang : So the two big ones to be aware of are Micron and Nvidia. So of course, two very big names in the chip making space. Those two companies alone account for about a third of the earnings growth we're looking at. There's a lot of other prevalent tech names in there as well. So Broadcom, SanDisk, EchoStar is one, Meta for example. And then there's actually also a few oil and gas companies, so you can attribute that to the sort of higher oil prices that we've seen. So it's a mix of some of those AI stars and then those oil and gas names that have been sort of unique beneficiaries of the geopolitical tensions in the Middle East.

Julie Chang: And what does this extreme concentration mean for the health of the broader S&P 500? Does it distort how healthy the rest of the index actually is?

Hannah Erin Lang : Yeah. So when I took a look at this profit growth data, I though, what if we look beyond Nvidia and Micron and take out these 10 companies with the biggest profit increases? What does this look like for the other 490? And if you take out those 10 all stars, the earnings growth for the S&P 500 for the third quarter drops from 30% to about 10%, which is a decent earnings growth number. So it's not at all the case that we are looking at a bad quarter for earnings growth for the rest of the market. It might just not be as stunning a quarter for profit growth as that headline number would maybe suggest.

Julie Chang: So what risks are posed by such concentrated earnings growth?

Hannah Erin Lang : So the impression I got from the professional investors that I spoke with is that this is not at all sort of a critical threat to the stock rally. It's true that for some time folks on Wall Street have been watching for and maybe getting a little bit more anxious to see the benefits of AI taking shape beyond the tech sector, which this example of concentrated earnings growth doesn't necessarily paint that picture. I think the real risk here is that a lot of the money managers that I've spoken with have cited this 30% profit growth number as one crucial logical reason why stock prices can keep moving higher. And I think when you look a little more closely, this is actually just one more way in which the stock market has come to depend heavily on this massive singular bet on AI. The idea that the productivity gains and money-making ability of artificial intelligence will be well worth the hundreds of billions of dollars being spent on it right now, we have seen that as soon as Wall Street starts to question that belief, even just a little bit, it can lead to pretty violent shifts in the market. So the risk post by concentrated earnings growth is essentially the same risk underpinning the entire market or the broader AI investing boom right now, that the technology ultimately won't be able to deliver on the massive sums of money that US companies are currently pouring into it. One investor, put it this way, the fear is that we're going to end up converting all these data centers into pickleball facilities.

Julie Chang: How vulnerable are the remaining S&P 500 companies if earnings growth fails to broaden out? In other words, if profit doesn't start spreading to other sectors, how risky is that for the typical company on Wall Street?

Hannah Erin Lang : I don't think there's a critical risk posed to the average company in the S&P right now. It's just that they're not benefiting from these eye-popping numbers that we're seeing at some of the biggest AI players. I do think that professional investors are getting a little more anxious to see the benefits of AI take shape at these other companies, whether that's in healthcare or real estate or at banks, for example. And ideally, investors want to see that happen kind of soon. That would be the next stage of this bull market. So it's not necessarily that other companies in the S&P 500 are struggling right now. They're just not necessarily seeing the benefits that the tech companies have from the AI boom.

Julie Chang: Are you worried about market concentration? If you're a listener on Spotify, leave us a comment with your thoughts. Still ahead, why top investors aren't hitting the panic button over big tech's massive AI spending? That's after the break. Welcome back. So we've talked about how we're seeing a few companies drive big growth in the S&P 500 right now, but some investors are not worried about that concentration at all. Why is that?

Hannah Erin Lang : Yeah, I mean a lot of it has to do with if you strip out those 10 superstars' profit growth for the S&P 500 year over year is still 10%. It's not that Micron and Nvidia and some of these other top earning stocks are patching over a bad quarter for earnings and making it look good, it's that they're taking a solid quarter and making it look really incredible. One of the big drivers for earnings at Micron and Nvidia is this memory shortage, right? So that's driving very large and temporary increases in profits. And again, that's something that investors say is reflected in the share prices of those stocks. Micron and Nvidia, they have such stunning year-over-year growth and profits. It's like 1,078%, 90% in the case of Nvidia. One reason why investors aren't all that concerned with the concentration of the earnings growth is that most people on the street seem to understand that the drivers of those massive increases are temporary in nature, and that's reflected in the movement of the price relative to the earnings forecast. So I think that gives analysts a lot of peace of mind and they have said to me, "Hey, if you look at valuations, which is sort of how investors are pricing stocks relative to their earnings, valuations have actually come down for the S&P 500 over the course of the year. So that means that Wall Street isn't overreacting to this earnings growth. In fact, they're being kind of reasonable about it and investors aren't necessarily piling in on these stocks or chasing this rally in a kind of FOMO driven way. And so what I heard from my interviews is investors are acting relatively rational in the face of these really extraordinary earnings numbers, and that gives them peace of mind as well.

Julie Chang: This conversation about the concentration of growth, I'm sure reminds some listeners about the dot-com boom and bust. So are we looking at another version of the dot-com bubble or is this time different?

Hannah Erin Lang : Yeah, I think that's the trillion-dollar question and one that a lot of people in the world of tech and finance are trying to answer right now. I will say that one key difference that came up in the course of reporting this piece is when you look back at those first crop of internet focused companies that we typically associate with the dot-com boom, they just weren't making money like this. The earnings just kind of weren't there. And I've had investors point that out to me. We're talking about a different set of market leaders that could ultimately lead to a different outcome.

Julie Chang: Okay. So if you're a regular investor holding an index fund right now, should you be changing your game plan?

Hannah Erin Lang : Yeah. So I will make the disclaimer that I am not a financial advisor. I would not claim to know where the markets could go from here, but I will say that this concentration risk that we're talking about in relation to earnings growth, in relation to just how the market is made up, that conversation has been present for pretty much the entire time that we have been in this AI-driven bull market. And at any point throughout the course of that, if you turned bearish and bet against these tech stocks, you would've missed out on some pretty generational returns. So I think even the skeptics on Wall Street are keeping that in mind.