US tech valuations stretched further as earnings contribute less

US tech companies’ share of S&P 500 earnings has been slipping even as their contribution to the index’s market value remains near multi-decade highs, raising concerns that their prices are further removed from underlying profit trends.

According to a Reuters analysis, tech companies accounted for 20.8% of the S&P 500’s total earnings in the third quarter, down from 22.8% three quarters earlier. At the same time, their share of the index’s market capitalization rose to 31.1% as of Friday, compared with about 30% at the start of the year.

Analysts warn that this disconnect, combined with the sector’s outsized weight in passive portfolios, could magnify any disappointment in earnings and trigger broader index-level declines.

“The wider gap between the tech sector’s percentage in the S&P 500 market cap is partly justified by genuine future earnings power and FCF (free cash flow) growth, but not entirely,” said Illia Kyslytskyi, head of research at Yaru Investments.

Tech stocks have driven the market to fresh record highs on expectations that AI will generate outsized profits, leaving valuations increasingly dependent on rapid earnings growth.

The tech-heavy Nasdaq Composite Index was trading at a forward P/E of 29.28 based on current-year earnings estimates, well above its 10-year average of 23.48 and higher than the S&P 500’s 24.35.

Although the tech sector delivered strong profits in the September quarter, led by AI names such as Nvidia, some analysts said the outlook for future earnings hinges on how effectively AI translates into revenue for clients, and how efficiently providers deploy their spending.

Alexander Lis, chief investment officer at Social Discover Ventures, said the so-called “Magnificent 7” tech stocks saw margins temporarily boosted by AI-related capex, with suppliers booking revenue upfront, suggesting profitability could normalise as spending slows.

The Nasdaq index is up 18.4% so far this year but has fallen over 3.5% this month.

Derek Izuel, portfolio manager at Shelton Capital Management, said tech stocks could see a mid-single-digit pullback if earnings fail to keep pace with valuations.

“A more severe pullback that results in the risk premium back to normal would be closer to a double-digit decline.”

(Reporting By Patturaja Murugaboopathy; with additional reporting by Gaurav Dogra in Bengaluru; Editing by Vidya Ranganathan)