A flurry of corporate earnings reports nudged interest rate worries out of the spotlight yesterday, but they didn't do much to improve the mood in the stock market. In fact, the mixed reviews coming from some key reporting companies, particularly in the technology sector, may be giving the market's growing legions of worry warts something new to fret about.
Despite some better-than-expected first-quarter profits at some big technology companies -- most notably Apple Computer Inc., whose stock soared yesterday on its strong report -- some disappointing company outlooks raised questions about whether the sector can live up to the lofty expectations built into its stock prices. With the prospect of higher interest rates already causing investors to rethink the valuations they had placed on stocks in many high-flying sectors, including technology, the uneven outlooks shook their confidence a little more.
The concern was etched all over technology stocks: The tech-heavy Nasdaq Stock Market composite index slumped 1.1 per cent to 2,202.17. The Toronto Stock Exchange's information technology subindex slipped 0.7 per cent.
It's worth noting that these stocks are falling from great heights: The Nasdaq index is up 46 per cent in the past year, while the TSX technology group is up 109 per cent. When you're up that high, it gets harder to impress investors, and easier to disappoint them.
Apple's results were, indeed, impressive. Profit was more than triple year-earlier levels, and topped analysts' expectations by 2 cents (U.S.) a share -- or 4 cents if you factor out a restructuring charge. Sales were up 29 per cent from a year earlier, and were 6 per cent above analysts' estimates. Apple's forecasts for the current quarter also topped expectations.
But Apple's results were propelled by the runaway success of its iPod digital music devices, something its competitors don't have, so its results aren't indicative of the industry as a whole.
On the other hand, the news was less rosy among the semiconductor manufacturers. Advanced Micro Devices Inc.'s first quarter did beat targets, but the company expects sales to show no growth in the second quarter. That came on the heels of Intel Corp.'s projection of second-quarter sales at the bottom end of analysts' estimates.
(Curiously, a third big chip maker, Texas Instruments, issued second-quarter guidance a bit above analysts' expectations, yet its stock got spanked anyway. You have to wonder whether investors took its outlook with a grain of salt, given the cautious views of its competitors and the fact that one of its biggest customers, Nokia, recently slashed its own sales outlook.)
The uncertainty among the chip makers is a bit disquieting, as these guys provide an essential building block used throughout the technology industry. If they're getting cautious about future sales, it suggests some risk of a slowdown across the sector. Such a prospect flies in the face of the assumptions built into technology stocks.
Analysts have been getting more bullish about tech earnings in recent weeks; they have raised their first-quarter year-over-year growth target for the sector to 52 per cent, from 46 per cent at the start of the quarter. The unofficial expectations are even higher.
That sort of optimism is priced into tech stocks, not only for this quarter but for several quarters to come. The Nasdaq composite stocks are trading at an astounding 78 times earnings for the trailing 12 months, which can only be justified if you assume a continuation of rapid profit growth. (Indeed, to meet the P/E ratio of 33 times based on projected profits for the next 12 months, which is still a bit pricey, the stocks that make up the index will have to more than double their combined share profit.)
So it's no wonder that anything but stellar results and outlooks would take the wind out of the sails of technology stocks, particularly when the threat of higher interest rates suggests that lower multiples are probably in the cards anyway.
The broader market, which has benefited from the strong earnings growth the tech sector has contributed, has to wonder where the slack will be picked up if, indeed, some of the heat is coming off technology earnings. It's yet another question at a time when many investors had hoped the quarterly earnings reports would be providing clear and comforting answers.
David Parkinson is the investment editor of Report on Business.