(Bloomberg) -- Chinese hardware technology stocks have been on a tear. The next challenge is showing the earnings to back it up.
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A surge in AI infrastructure spending by hyperscalers, combined with Beijing's push to foster homegrown tech champions, has sent the chip-heavy STAR 50 Index up by a record 64% this quarter. Investors pulling money out of struggling consumer and retail stocks have further amplified the moves.
While few in the market doubt China's long-term tech story, there are concerns whether surging share prices and exuberant sentiment have gotten ahead of themselves. As earnings season kick off this week with some preliminary announcements, companies have a chance to prove the rally is justified. "Sentiment feels like it's near a temporary peak," said Shi Junbo, a fund manager at Hangzhou Xiyan Asset Management. "A lot of AI hardware leaders have baked current growth into their share prices, and it's getting hard to justify pushing them higher on fundamentals alone."
Money is already flowing into niche corners of the AI supply chain, including materials and components. Shi said this spillover suggests many investors are no longer confident bidding up the biggest winners at current levels.
Take Zhongji Innolight Co., a maker of optical communications devices. The stocks is up 132% this quarter and trading at about 40 times forward earnings, versus 33 times for the Dow Jones US Telecommunications Equipment Index. It's also around 20% above the average analyst price target compiled by Bloomberg.
The broader profit outlook hasn't kept pace with share prices. Analysts have raised earnings estimates for the STAR 50 by more than 4% this quarter, according to data compiled by Bloomberg. That pales in comparison to the index's surge, leaving it trading at 69 times forward earnings, a record high.
For now, though, most analysts are sticking with their bullish views. Goldman Sachs Group Inc. prefers Chinese mainland-listed shares over those in Hong Kong, citing stronger earnings performance by onshore indexes led by AI profits shifting toward hardware firms. Morgan Stanley also favors mainland markets because they have a bigger concentration of "hard-core" tech names.