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Earnings Preview: Can the Tech Sector Beat Projections Again?

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December 14, 2016
Technology, earnings: How will the SPX tech stocks sector fare for Q4 2016?

Some of the largest U.S. technology companies stumbled in the first half of this year, but they appear to have not only found their footing in the second half, but also managed to climb onto solid territory as they prepare for quarterly results.

Last quarter’s earnings for the S&P 500 Index (SPX) information technology sector were a pleasant surprise, according to FactSet. Some 89% of the reporting companies turned in results that outpaced Wall Street’s expectations, while another 6% were in line with expectations. With 95% of firms beating or falling in line with expectations, tech led all sectors. Utilities, at 82%, was a distant second.

Tech earnings also recorded the highest growth rate of any sector at 11%, or $54.4 billion, compared with $49.0 billion a year ago, according to Thomson Reuters. Will the sector be able to repeat or top that?

Perhaps. Consensus among analysts reporting to Thomson Reuters see tech earnings climbing 7.1% in Q4, and these estimates have been rising throughout the last three quarters. If the sector can continue to outpace estimates at the rate that it did in Q3, the sector may deliver another robust quarter.

What “Trump Bump”?

Although the tech sector appeared to have missed the so-called “Trump bump”—the overall positive run in the markets to record benchmark levels after the presidential elections—analysts attributed much of that to shares of Apple (AAPL), which are heavily weighted on the sector index and were a target during Trump’s campaign. AAPL stock, which struggled throughout much of 2016, was on a downward trajectory before and just after the election, but has since edged higher.

Tech stocks struggled to keep pace with SPX throughout most of 2016. And a look at the combined performance of six of the largest technology firms—AAPL, Microsoft (MSFT), Netflix (NFLX), Yahoo! (YHOO), Intel (INTC), and IBM (IBM)—shows how these stocks moved farther apart from the overall market as the year progressed. After spending most of 2016 in negative territory, the tech subset finally turned higher for the year in mid-October, but the gap between the sector and the S&P 500 widened, as shown in figure 1. 

Technology stocks and SPX

FIGURE 1: TOP TECH STOCKS RELATIVE TO SPX.

This chart, plotted on the thinkorswim® platform from TD Ameritrade, illustrates the combined performance year to date through late November of six of the largest technology firms versus the S&P 500 Index (SPX). The tech stocks managed to edge into positive territory in mid-October, but weren’t able to keep up with the SPX, which was up more than 15% in late November versus the 4.8% gain of the group. For illustrative purposes only. Past performance does not guarantee future results.

Challenges Ahead

AAPL, which in the last reporting period turned in its first-ever quarter of declining sales of the iPhone (its biggest revenue generator), said at the time that it expected sales to climb in the coming quarter. Yet, CEO Tim Cook acknowledged that the company was facing some iPhone component-supply challenges that may put a dent in his efforts to advance sales. Analysts are quick to note that he’s said that in prior quarters, and AAPL’s “supply-chain prowess” came through with enough supply to meet demand.

MSFT is still facing the challenges of transforming its core business into cloud computing at a time when bigger companies, namely Amazon (AMZN), are dominating the landscape. MSFT recently announced plans to jump into quantum computing, a move that analysts say may be another big revenue generator as the company’s core shifts from retail PC software.

NFLX has been adding subscribers at a robust rate, which has helped grow revenues, but analysts are wondering how long it can continue to be what one analyst called the “unstoppable lead in the Internet TV business.”

The Trump Quandary

Some analysts fear the tech sector could face scrutiny under a Trump administration—although there is still much uncertainty as to what lies ahead. If Trump is able to follow through on campaign rhetoric, technology companies like AAPL, MSFT, INTC, and IBM may find themselves dealing with labor and manufacturing issues.

Many tech companies hire foreign skilled labor to help steward engineering and tech advances and innovation. If there are tighter rules around visa programs, analysts say it may be harder for those firms to attract high-caliber candidates who are not U.S. born.

Also, tougher trade policies against China, for example, which Trump labeled as an unfair trade partner, could force companies like AAPL to find new manufacturing bases. Most iPhones, for example, are assembled in China, as are a significant portion of other tech products, according to analysts. If Trump’s proposal to slap as much as a 45% tariff on goods coming from China is ever implemented—and, again, there’s plenty of ambiguity on whether that would ever come to pass—that may force AAPL to move operations elsewhere. To the U.S., as Trump has suggested? Not likely, analysts say. There are other places where labor would be cheaper.

Any protectionist stance may affect the top and bottom lines of other tech leaders like Facebook (FB) and Amazon (AMZN), which report in securities filings that large percentages of their revenues are generated from outside the U.S. and Canada.

And then there’s the value of the dollar, which surged after the election to levels not seen since 2003. Investors had seen some of the impact of the rising dollar in previous quarters, but a more pronounced rise in the value of the dollar could create a headwind for technology, says Sam Stovall, chief investment strategist for CFRA.

What may help multinationals with huge cash hoards is Trump’s proposal to offer a tax holiday of sorts to encourage U.S. firms to repatriate that money back home. AAPL and MSFT, for example, are said to have hundreds of billions of dollars in cash, and in a tax policy change, the hope is that they'll bring it back to the U.S. and invest domestically. He talked of a special one-off 10% tax on repatriated money—a move that will require Congressional approval.

TD Ameritrade clients can get a visual view of the financial sector via a heat map in the thinkorswim platform. (See figure 2.) The size of the squares indicate the market cap of that company. With one click, you can quickly access fundamentals, news, charts, and more. 

Technology stocks heat map

FIGURE 2: TECHNOLOGY SECTOR HEAT MAP.

To access this heat map in the thinkorswim platform, click MarketWatch > Visualize > Indices > S&P 500 > Information Technology. Image source: The thinkorswim® platform from TD AmeritradeFor illustrative purposes only. Past performance does not guarantee future results.

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