Three clouds forming over S&P 500 earnings transparency

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S&P 500 Relative Value Cheat Sheet

Three clouds forming over S&P 500

earnings transparency

Better valuations on earnings, not on cash & sales

The forward PE for the S&P 500 has compressed this year by 14% to 20x, driven by a

23% upward revision to NTM EPS (Exhibit 1) – the multiple is still high (73rd pctl since

1986) but has dropped to multi-year lows. However, on sales and free cash, the index

trades at record highs. Why? YoY sales growth has undershot capex growth by 17% vs

1% avg. over the last 40 years (similar spike in the late 90s). Divergence in metrics

signals less earnings transparency where drivers may include capital intensity, leverage

and outsized growth from one-time marks, factors correlated with higher risk premia.

1) Capital light to clunky: 15% - 30% derating potential

Since 1986, investors have paid up for innovation: the top 50 S&P 500 companies by

capex/sales have traded at average EV/EBITDA discounts of 26% and 14% to the top 50

by R&D/sales and buybacks/sales, respectively. Hyperscalers defy this; at an average 19x

EV/EBITDA vs. 15x three years ago, despite a shift to capex spend vs. R&D and buybacks

(Exhibit 7). Caveat: if AI spend heralds an industrial revolution, historical multiple analysis

is less relevant. But if it proves a more conventional capex cycle, history argues for a 1530% derating as the market reprices capital intensity over innovation.

2) Full leverage picture sits in footnotes

Hyperscalers have swung from ~$200b net cash in 2019 to ~$140b net debt, yet strong

operating cash flow and IG ratings put solvency risk light-years away. Debt-financed

capex still makes sense, as debt is cheaper than equity (though the two have begun to

converge, Exhibit 13). The catch: capex is migrating from hard assets to off-balancesheet leases, masking true leverage. Add the five Hyperscalers' $2.3T of footnote

obligations to S&P 500 balance sheets and the index’s debt-to-cap rises from 9.5% to

12.6% (Exhibit 12).

3) Cash diverging from earnings…

2Q S&P 500 EPS growth is 27% - incredibly healthy, but investment gains from Google

and Amazon would push that growth rate to 45% (+18ppt), and the gap between cash

…