AI Spending Boom Has Not Yet Boosted Corporate Profit Margins! At Least Not Yet

According to Barron's, the AI revolution was supposed to enhance the financial performance of companies across industries. AI was expected to help businesses reduce costs and improve efficiency, thereby boosting profit margins. However, so far, this has not materialized.

Torsten Sløk, chief economist at Apollo, recently pointed out in a report that since OpenAI launched ChatGPT at the end of 2022, net profit margins in the technology and communication services sectors have risen. However, in many other industries—such as healthcare, consumer staples, energy, and materials—profit margins have either remained flat or declined during the same period.

In other words, Nvidia (NVDA-US) and the ultra-large cloud service providers among the 'Magnificent Seven' U.S. tech giants are benefiting from massive AI spending. But the so-called 'other 493 companies' in the S&P 500 index have not yet seen such benefits. At least not yet.

Sløk wrote: 'The AI capital expenditure boom is currently reflected only in the sellers’ profit margins, not in the buyers’. This is important because the longer it takes for the S&P 493 companies to generate returns on their investments, the greater the downside risk for an economy and market so heavily concentrated on AI-related transactions.'

According to Sløk’s data, the 'Magnificent Seven' now have a net profit margin of about 25%, up from around 15% at the end of 2023. In contrast, the so-called 'other 493 companies' in the S&P 500 have a net profit margin of about 10%. Over the past three years, profit margins for these companies have remained largely stable.

Sløk says he ultimately expects profit margins to expand in industries outside of tech and telecom services as well, 'but the speed at which this happens is crucial for the market.'

In another report from early July, Sløk noted that many investors expect AI spending to deliver tangible benefits by 2028. Therefore, the market needs to see so-called 'real-world results' over the next two years.

Sløk warned: 'With so much riding on just a few companies, if returns come in slower than expected, it won’t just be a problem for one sector—it could push the economy into recession and trigger a correction in the S&P 500 index.'

Major stock indices are currently at or near all-time highs, largely driven by optimism surrounding AI. As a result, for enterprises adopting tools like ChatGPT, Anthropic’s Claude, and other large language models, it is critical to demonstrate to investors that their AI investments will have a clear and positive impact on profitability.

Rob Almeida, global investment strategist at MFS Investment Management, said, 'This rally depends on whether AI can be commercialized at the pace the market expects.' He added that given the multi-year bull market, 'investors need to be cautious and thoughtful, but they usually aren’t—and a large amount of retail investor money is currently in risk-on mode.'

This isn’t to say AI is a bubble about to burst. But for non-tech companies in retail, financial services, and healthcare, it may simply take more time before they see actual returns from AI spending.

Given this, Jonathan Curtis, portfolio manager at Franklin Equity Group, suggests investors should primarily focus on companies that help 'run AI'—that is, the ultra-large cloud service providers.

Curtis said, 'You’re starting to see investors confidently return to the “Magnificent Seven” as a safe haven.'

The Roundhill Magnificent Seven ETF, which holds Nvidia, Apple (AAPL-US), Alphabet (GOOGL-US), Microsoft (MSFT-US), Amazon (AMZN-US), Meta Platforms (META-US), and Tesla (TSLA-US), has risen nearly 5% since August. Renewed trading momentum in large-cap tech stocks has also pushed the S&P 500 up 3.5% so far this month.

For now, this is fine, as investors are celebrating strong earnings from the tech sector. But AI spending must produce tangible results—especially now that the S&P 500 is trading at a price-to-earnings ratio of about 22 times this year’s estimated earnings.

If the profit margins of all these companies writing huge AI checks to cloud providers don’t begin to show meaningful improvement, it will become increasingly difficult to justify further market gains.