Why do tech stocks become "cheaper as they rise"? 80% profit surge supports valuations, but if AI expectations fall short, they will instantly become expensive.

Zhihu Finance APP notes that in a bear market, it often takes a sledgehammer to crush stock prices, making shares much cheaper. However, tech stocks have found another way.

At the low in July this year, the forward price-to-earnings ratio (the price investors pay for expected earnings) of tech stocks had fallen by about 30% compared to a year earlier—declines of this magnitude last appeared during the bursting of the internet bubble and the financial crisis.

This time, however, the S&P 500 Index is hovering near all-time highs. This timing makes the situation even stranger.

The Technology Select Sector SPDR Fund has just rebounded strongly from its March 30 low. If measured by its 45-day rate of change (the percentage move in price over the past 45 trading days), this is the strongest surge in XLK’s history since records began in 1999.

For the Philadelphia Semiconductor Index, only the surge in March 2000 was stronger, according to historical data dating back to 1994.

So how can stocks soar sky-high while still getting cheaper?

Consider a stock trading at $100, with expected earnings of $5. Investors are paying $20 for every $1 of expected profit, so its forward P/E ratio is 20.

If the stock rises 40% to $140, it seems more expensive.

But suppose its expected earnings jump 80% to $9. Now, investors are paying just about $16 for every $1 of expected profit.

The share price has climbed, but the stock has actually become cheaper.

A similar phenomenon is playing out across the tech sector. Over the past year, tech stock prices have jumped about 40%, while expected earnings have soared around 80%. Earnings growth has outpaced the rise in share prices.

Bear markets usually achieve this through pain: share prices plunge, economic downturns slash profit expectations, and optimism gets knocked out of investors’ minds. By the time the dust has settled, buyers can usually pick up surviving earnings for much lower prices.

This helps explain why some of the strongest rebounds often begin when economic headlines still look dire. The market often starts pricing in a recovery before it actually arrives.

This time, tech stocks have captured most of the benefit, without dragging the entire market into demolition mode.

But there’s one obvious way this setup could fall apart.

Only if those expected profits actually materialize can the lower price-to-earnings ratios be maintained.

Large tech firms are pouring massive funds into chips, data centers, networks, and energy. Investors are already asking: who will make money out of this AI spending boom, and who will end up footing the bill?

If AI capacity gets overbuilt, customers slow spending, chip prices soften, or economic shocks hit tech budgets, analysts may start cutting those future profit forecasts.

At that point, this trick starts working in reverse.

The same $140 stock with expected earnings of $9 has a P/E of about 16. If earnings expectations are cut to $6, with the price unchanged, the P/E suddenly soars above 23.

Nothing has happened to the stock itself; it simply becomes much more expensive overnight. Now, the bull case boils down to one thing: profits must be delivered.