The S&P 500 Might Be Too Cheap For The AI Era

The S&P 500 Might Be Too Cheap For The AI Era
Stéphane Renevier, CFA

6 months ago1 min

The magic of AI is widely expected to supercharge productivity, bump up profit margins, and lift up companies' earnings. But the question on investors’ minds is: how exactly will it impact the overall S&P 500 index? Goldman Sachs recently crunched the numbers, and found that while there’s more upside than what’s currently in the price, it’s not a sky’s-the-limit situation.

Goldman used the Dividend Discount Model (DDM), a handy tool for working out the fair value of a stock (or an entire index). It's simple: you take your expected dividends and divide them by the difference between your desired return and the predicted dividend growth. Then, put AI in the picture, and assume that in ten years it'll be as common as smartphones are today, and will have pushed productivity up by 1.5% and real GDP growth by 1.1% – annually, both of them, for a decade. And what you find is that the S&P 500’s fair value would be about 9% higher than it is today, everything else being equal.

Playing around with different assumptions, Goldman’s analysts estimate that the fair value is likely to be anywhere from 5% to 14% higher than current prices.

Admittedly, the real world isn't as neat and tidy as the Dividend Discount Model. But this little tool offers a practical way to weigh up the possible impact of different scenarios on valuations. And sure, there are scenarios where the fair value could shoot even higher. But in a sea of AI hype, having a solid number as your anchor just might stop you from being swept away by the current tide of excitement.



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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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