As technology earnings season approaches, investors face historic dispersion in returns. The receivers of capital (“ROCs”) of this hyperscale-led capital spending boom are vastly outperforming the spenders of capital (“SOCs”). In my opinion, this widening dispersion could bring about a narrative change within this debate.
Positive Correlation
ROCs and SOCs can live harmoniously. For the first years of this AI CapEx boom, the returns of stock prices between these two groups were positively correlated as the market capitalizations of each bucket increased in tandem. Sure, ROCs (comprising NVDA, AVGO, AMD, MU, and other semiconductors) vastly outperformed SOCs (MSFT, AMZN, GOOGL, META, and others in the cloud computing industry), as shown below. But the two groups moved largely in tandem.
The logic of this mutual market cap increase was sound as well – the SOCs likely saw a positive return on investment in the products of the ROCs, and this could drive sustainable spending levels driven by increasing profitability.
But Something’s Changed
Also detailed in the chart above is the most recent period of returns. Over the past 26 weeks, SOCs are down while ROCs are up. That’s a change. Value is now being transferred from the SOCs to the ROCs, instead of mutual growth. In my opinion, there could be some signal in these vastly disperse returns. Have the returns on investments vastly deteriorated? Or have spending levels reached an unsustainable pace? While the answer is unknowable, it likely is a bit of both.
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However, earnings season will give Wall Street a chance to hear directly from the spenders. Capital spending from the hyperscalers will be under scrutiny – and likely to directly impact the ROCs – but there is a needle they can thread to restore the mutual gains: show the outsized potential returns. By many accounts, AI usage has boomed during the previous three months. That should lead to high utilization of these expensive data centers, which potentially paves the way for revenue acceleration at the SOCs.
The spenders and receivers of capital during this AI CapEx boom are opposite sides of the same coin. Investors rewarded both sides during the first years of this CapEx boom, but something has changed in recent months. The SOCs are down while the ROCs are up – value is being transferred instead of mutually created. In my opinion, that raises the potential for a narrative shift and the need for SOCs to show the returns they are pursuing. Earnings season can’t come soon enough for tech investors, and they’re likely to demand answers.
For more content by Blake Anderson, CFA®, Director, Portfolio Management, click here.
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