Friday, July 19, 2013
With nothing on the economic calendar and the Bernanke testimony now behind us, the market today will likely give an undivided attention to the earnings season. The big negative surprises from Google (GOOG) and Microsoft (MSFT) will put a spotlight on the weak earnings picture of this key sector in today’s session. But having seen Q2 results from more than 20% of the S&P 500 members that combined account for more 30% of the index’s total market capitalization, we have a good enough sample of Q2 results to start judging this earnings season as well.
Total Q2 earnings are on track to reach a new all-time quarterly record and the aggregate growth rates and beat ratios are broadly in-line with what we saw in the previous quarter. But results from the Finance sector are making the aggregate numbers look better than they actually are. It’s not so reassuring outside of Finance and results from the Technology sector tell a better story of what is really unfolding on the earnings front.
No business can afford to sit on its past laurels and hope for a better future, but the issue is particularly pronounced in the Technology space where innovations and new technologies come through and disrupt the existing order of business. We see this issue at play in both the Google and Microsoft earnings misses. Microsoft’s problems are partly company specific, a function of management’s inability to follow through efficiently on any major initiative. But a big contributor to the company’s woes have resulted from the steady erosion of PC due to tablets and other mobile platforms. Microsoft isn’t suffering alone – from chip makers like Intel (INTC) and Advanced Micro Devices (AMD) to PC makers like Hewlett-Packard (HPQ) and Dell (DELL) - it has plenty of company on this front.
Google is facing the same issue. After all, the erosion of Google’s search-ad prices (the so-called cost per click or CPC) is a direct function of traffic migration from the desktop to mobile platforms. Google may be able to offset its CPC issue with increased volume, but Intel, Microsoft and others have to fundamentally realign their businesses to succeed.
Beyond these structural and secular issues is the cyclical problem of low demand for the sector’s products and services resulting from weak global capital spending trends. Hard to envision the sector’s fortunes improving without a positive shift in enterprise spending. And keep in mind that unlike the banking space which has more of a domestic orientation, the Technology market is far more global in nature. The outlook for the U.S. economy may be improving, but hardly anyone is betting on the global economy getting better in the near to medium term.
So, how is the Technology sector’s results shaping up? They are not very good, but the underperformance wasn’t entirely unexpected.
As of this morning, total earnings for the 44.8% of the sector’s total market capitalization that have reported results are down -8.1% from the same period last year on +3% higher revenues, highlighting the sector’s margin challenges. This is materially weaker growth performance than what we saw from the same group of companies in Q1 or over the preceding four quarters.
The Scorecard for the broader S&P 500 as of this morning shows Q2 results from 103 S&P 500 companies or 20.6% of the index’s total membership that combined account for 31.8% of its total market capitalization. Total earnings for these 103 companies are up +8.1%, with 61.2% beating earnings expectations. On the revenue side, we have a growth rate of +4.6% and 44.7% are coming ahead of top-line expectations. The earnings and revenue growth rates seen thus far are broadly in-line with what we have seen from the same group of 103 companies in recent quarters.
The Finance sector is helping hide a lot of weakness in the aggregate earnings picture. Strip out the strong growth reported by the Finance sector and total earnings growth for the remaining S&P 500 companies turn negative – down -2.9%. This is weaker than what these same companies reported in Q1. There are few positive surprises outside of Finance as well, with the earnings and revenue beat ratios outside of Finance tracking below Q1’s levels. Bottom line, the earnings picture outside of Finance are very weak and perhaps inconsistent with a stock market at all-time record levels.
Director of Research