By F.A.S.T. Graphs. Originally published at ValueWalk.
A little less than half of second quarter tech earnings are on the books now, and it seems as if Wall Street’s love affair with the sector is waning. At the beginning of the season, investors expected great things from tech earnings, but now, sentiment is shifting toward the negative with approximately 60% of the sector having yet to report.
Last night Twitter Inc (NYSE:TWTR) and Yelp Inc (NYSE:YELP) disappointed, and tonight Facebook Inc (NASDAQ:FB) is scheduled to report.
Facebook results will be closely watching being one of the last big tech companies to report Q2 earnings.
What a difference a week makes for tech earnings
Wall Street was downright ecstatic with tech earnings the week before last after Netflix, Inc. (NASDAQ:NFLX), Google Inc (NASDAQ:GOOG), Intel Corporation (NASDAQ:INTC) and eBay Inc (NASDAQ:EBAY) smashed estimates. After strong positive sentiment leading into second quarter earnings season, it seemed as if the excitement would remain, but last week the tided started to turn.
S&P Capital IQ analyst Lindsey Bell noted that the S&P 500 Information Technology sector index ended the week of July 17 up 5.3%. However, the following week, investors started to turn sour on the tech sector, even following solid earnings from Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT) (not counting net loss). The big problem was their guidance, and as of last week Thursday, the IT sector index had fallen 1.9%.
Why are investors so indecisive on tech earnings?
Bell believes Wall Street doesn’t really know what to make of tech earnings because going into the second quarter reporting period, the bar was set pretty low. At the beginning of the year, it was expected that tech would be ranked fourth in terms of growth rates in the S&P 500. But then in the first quarter, currency headwinds hit the sector, resulting in multiple firms trimming their estimates for the rest of this year.
Here’s a look at the trend in earnings growth projections for the tech sector since the beginning of the year (Graphs are courtesy S&P Capital IQ.):
Because of how quickly consensus estimates declined, it seemed as if tech earnings could exceed them. Indeed, investors were pretty sure that Netflix and Google would post strong results as their share prices rose ahead of their earnings reports and then kept rising afterward.
Guidance was again a focus for investors, as Netflix’s guidance for third quarter earnings beat estimates by 24%. Google’s new chief financial officer, Ruth Porat, told investors on the company’s earnings call that she’s instituting tighter cost controls, which was certainly good news. Here’s a look at some of the key tech earnings reports that have come in so far.
Facebook : Apple and Microsoft similarities
Bell suggested that the reason Apple shares have pulled since the company’s earnings report was because expectations may have gotten too high. She noted that Wall Street tends to expect a lot out of Apple because it has such a huge weighting in the S&P 500 and has a track record of beating expectations.
Of course expectations haven’t been as high for Microsoft because the PC market has yet to stabilize, but Bell thinks Microsoft and Apple share one big thing. Wall Street remains uncertain about where the next growth driver will come from.
There are signs that the Apple Watch isn’t doing very well, and management’s decision not to release sales numbers for the device hasn’t helped any. China also remains a big question mark for Apple. For Microsoft, the transition to cloud services is taking longer than investors had hoped.
Facebook : Where will tech earnings end up?
Bell thinks that once all the tech earnings reports are in, the sector will show a growth rate much higher than the 2% that was first expected and even the currently expected 4.1% growth rate. She also thinks there’s still “plenty of value” in the tech sector but notes that this year remains a “stock-pickers market.”
The tech sector is currently trading at a discount of 25% to its 15-year average price to earnings ratio. She recommends that investors interested in the tech sector look for “companies with fundamental growth opportunities, serving strong end markets.”
Sign up for ValueWalk’s free newsletter here.
