Capex is King in US stock market
Companies spending big are seeing big rewards.
“Invest in yourself.”
It’s generally good advice. But lately, the stock market is rewarding a specific kind of investment.
The S&P 500’s march to fresh record highs over the past month has been driven by companies that have been investing to expand operations and boost research and development. Companies that have focused on investing by buying back their own shares or dividend payments to shareholders are lagging behind.
Goldman Sachs compiled a basket of 50 US stocks that spend the most on capital expenditures (capex) and research and development, as a share of their market value, over the past year. That cohort has surged 5.4% over the past month, through May 22. A separate basket of the 50 stocks with the most generous shareholder return programs is up just 1.6%.
The one-month performance premium for capex-heavy companies reached about 4 percentage point in recent sessions. That gap in returns is in the 96th percentile based on data going back to January 1995.
On a general level, investors rewarding companies for capital investment indicates they aren’t worried about an imminent US recession, which was a chief concern from mid-2022 through early 2024. If people believed a downturn was around the corner, no one would want to be betting on firms that are ramping up their productive capacity. So if nominal growth stays elevated, there are likely better returns on investment than merely giving money back to shareholders.
More specifically in this day and age, capex-heavy companies beating their more shareholder-return oriented peers hints at a degree of optimism that the seeds planted during this AI boom will bear fruit in the quarters and years to come by driving efficiencies and profit growth. Think data centers and the like.
Analysts have been revising expectations for capex by S&P 500 companies unusally aggressively to the upside. As of mid-May, the three-month change in what capital spending will be in one year’s time was up 5%.
Increasing business investment is an amazing way to drive profit growth at the index level for the stock market. When Company A spends on capex, that’s revenue (and hopefully, profits) for Company B. But when Company A spends on capex, it’s not Company A’s expense until it begins to erode the value of that new property, plant, or equipment by using it (depreciation). So in an accounting sense, business investment helps one company’s revenues go up without making another company’s costs go up. Magic!
But to acknowledge Easterbrook’s law that “all economic news is always bad,” the flip side: Company management responds to incentives and by rewarding investment, it makes companies more likely to invest, which is the first step along the road to over-investing — which is bad!
The US economy hasn’t really had a normal boom-bust investment-driven economic cycle in quite some time. The magnitude of AI-linked capex hasn’t clearly crescendoed to such a level yet, but it’s certainly something to be mindful of going forward.
