3 Tech ETFs to Watch on the Microsoft Earnings Beat

The technology sector has so far been trending downward with disappointing earnings numbers from the big tech giants like Intel (INTC) and International Business Machines (IBM). But the second quarter 2014 earnings beat from the software giant – Microsoft (MSFT) – after the market closed yesterday has spread optimism across the entire space (read: Sluggish Intel Q4 Earnings Puts These ETFs in Focus).

Microsoft Results in Focus

The company reported earnings of 78 cents per share, outpacing the Zacks Consensus Estimate of 68 cents and improving from the year-ago earnings by 2 cents. Revenue grew 14% to a record $24.52 billion and outpaced our estimate of $23.49 billion. This represents Microsoft’s best performance in at least the last four quarters.

Robust performances were largely credited to the surprise jump in consumer hardware sales as demand for Xbox videogame console and new Surface tablets gained traction during the holiday season. Higher software sales such as Azure and Office 365 also led to the strong revenue (read: 3 ETFs to Watch for Big Moves This Year).

Growth in software and hardware revenue more than offset the steep decline in personal computer sales. The company expects this trend to continue in Q3 2014 and growth in Xbox and Surface tablets to again drive revenue.

Microsoft is in the midst of implementing a reorganization and is on the way to close its acquisition of $7.2 billion Nokia's mobile phone business this quarter. The deal would strengthen the competitive position and would add revenue streams and profit opportunities for Microsoft. For example, Microsoft’s gross margin on the sale of one Nokia handset would increase from the current $10 to $40 (read: 3 Tech ETFs to Watch on Microsoft-Nokia Deal).

Further, Microsoft is still looking for a candidate who can replace the current CEO – Steve Ballmer – who is expected to retire sometime this year. The hunt for the new CEO will continue to be a major story for Microsoft, at least for the near term.

Market Impact

Based on this solid earnings beat, Microsoft shares rose 3.5% in after-market trading on Thursday. As such, the stock has a potential to move upward in the coming few trading sessions. However, the outlook still looks bleak given that MSFT has Zacks Rank #4 (Sell) and a poor Zacks Industry Rank in the bottom 35% which suggests volatile trading ahead.

ETFs to Watch

The volatile trading in MSFT could create a good opportunity for some investors who believe in the company’s hardware and software growth businesses. For those investors, we have highlighted three tech ETFs having large allocation to this software giant that could be in focus in coming days (see: all the Technology ETFs here):

iShares Dow Jones US Technology ETF (IYW)

This ETF tracks the Dow Jones US Technology Index, giving investors exposure to 143 stocks. The fund has AUM of nearly $3.2 billion while charging 45 bps in fees and expenses. Volume is good as it exchanges more than 283,000 shares a day.

Microsoft occupies the third position in the basket with 9.19% of assets. The portfolio is evenly split between technology hardware and equipment, and software and computer services. The fund added 0.72% in the year-to-date period and has a Zacks ETF Rank of 2 or ‘Buy’ with a ‘High’ risk outlook.

Vanguard Information Technology ETF (VGT)

This fund provides exposure to a large basket of 414 technology stocks with AUM of $4.7 billion. This is done by tracking the MSCI US Investable Market Information Technology 25/50 Index. The ETF has 0.14% in expense ratio while volume is good (read: Best ETF Strategies for 2014).

Again here, MSFT is the third firm with 7.9% allocation. From a sector perspective, Internet software & services and computer hardware take the largest share with 16% each. VGT gained 0.63% year-to-date and has a Zacks ETF Rank of 1 or ‘Strong Buy’ with a ‘Low’ risk outlook.

Select Sector SPDR Technology ETF (XLK)

The most popular technology ETF on the market, XLK follows the Technology Select Sector Index. This fund manages about $13.4 billion in asset base and trades in heavy volume of roughly 6.5 million.

The ETF charges 18 bps in fees per year from investors. In total, the fund holds about 73 securities in its basket.

Of these firms, Microsoft takes the third spot, making up 7.84% of the assets. In terms of industrial exposure, the fund is widely spread across computer & peripherals, IT services, software and Internet software & services that make up for double-digit allocation. XLK is up 0.22% so far this year and has a Zacks ETF Rank of 3 or ‘Hold’ with a ‘Medium’ risk outlook.

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