Anyone distracted this month by the Reddit-fueled circus of stocks this month may have missed an important fundamental story: a great earnings season for tech companies that made the group’s stocks outperform the market again.
With more than half of the S&P 500 earnings reports on the books, tech companies love Skyworks Solutions Inc. and Paypal Holdings Inc. leads all other major sectors in the reference index with more than 95% better earnings expectations, according to data collected by Bloomberg. In terms of sales, 88% exceeded estimates.
The strong performance has helped technology stock earnings rebound after months when the group lagged cyclical sectors such as manufacturing and services, which tend to benefit the most from an improving economy. Since earnings season began on Jan. 15, the S&P 500 Information Technology Sector Index is up 6.2%, second only to the communications services group that employs tech giants like Alphabet Inc. and Facebook Inc. includes.
“They had great earnings that you just can’t ignore,” said Gary Bradshaw, a portfolio manager at Hodges Capital Management, of technology companies. “This earnings season shows that they will continue to grow at a solid pace.”
By 2021, technology stocks were are expected to underperform compared to other industries poised for faster earnings growth. A major pillar of their strength last year – the digital services and hardware that were so much in demand during the Covid-19 pandemic – would be left out as vaccines slowly normalized the economy, it was thought. .
For the time being, strong demand shows little sign of declining. Wall Street has taken note of the performance and raised earnings expectations after holding them flat for months. Analysts are now predicting earnings growth of 11% in the fourth quarter, a four-fold increase from two weeks ago. Earnings expectations for the first three months of 2021 are up 40% since early January in the biggest gains among the 11 major industry groups, according to data collected by Bloomberg Intelligence.
A concern for bulls is the lethargic stock response to good earnings reports from the largest US tech companies. Of the five largest stocks in the market, Alphabet Inc. and Microsoft Corp. the only companies whose shares are higher after their earnings reports. The Google parent has since gained 8.8% reported revenues and earnings per share on Feb. 2 that exceeded analysts’ highest estimates, while Microsoft is up 4.3% since Jan. 26.
Despite surpassing estimates for nearly every metric, Apple is down 3.7% since the report. Amazon.com Inc., whose sales forecasts far exceed analyst estimates, are down 0.8% since results on Feb. 2.
Sky-high valuations
According to Jason Benowitz, a senior portfolio manager at Roosevelt Investment Group, the muted enthusiasm of investors is likely to be related to high valuations relative to bargains in cyclical sectors and lurking anti-trust risks.
“These are formidable companies that are highly profitable and can adapt to the environment and deliver results for shareholders,” he said. “The things that hold them back relatively are still there and I am not convinced they will perform better in 2021.”
Some of the biggest surprises come from chip makers such as Skyworks Solutions and software companies such as ServiceNow Inc. Both stocks have risen at least 12% since the results were published.
Network giants include companies reporting earnings in the coming week Cisco Systems Inc., social media company Twitter Inc. and online travel company Expedia Group Inc.
S&P 500 tech stocks are trading at 36 times reported earnings, compared to less than 32 for the broader index. Concerns about possible regulation should make it more difficult for technology companies to continue to outperform given the premium they charge with the group trading near the most expensive valuation multiples in nearly two decades, said Matt Maley, chief market strategist at Miller Tabak + Co.
“With the new government, there will be a more diligent effort to put in place some real regulations against some of these technology mega caps,” said Maley. “It’s not going to kill them and burst the bubble, but this could create headwinds, and that’s a major concern for many investors. That’s one of the few things that has dual support. “