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Techs sweat the second half
Earnings should be great in 2Q but Street frets about slowing earnings growth later in the year.
May 24, 2004: 3:27 PM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - For tech investors, it looks like there ain't no cure for the second half blues.

Earnings from technology companies, by and large, were fantastic in the first quarter. And with the month of May winding down, tech earnings are looking pretty strong for the second quarter as well.

According to Thomson First Call, 36 percent of the second quarter preannouncements through Friday have been positive while 45 percent have been below expectations. At this time a year ago, only 28 percent of companies raised guidance while 52 percent warned.

Tech stocks have cooled off this year despite strong earnings.  
Tech stocks have cooled off this year despite strong earnings.

And estimates continue to rise for the sector. As of Friday, analysts were predicting 56 percent year over year earnings growth, compared to projections of 51 percent at the beginning of April and 47 percent at the beginning of the year.

Still, tech stocks are not having a very good year. The Nasdaq has fallen 4 percent in 2004. And chip stocks have taken a particularly notable hit. The Philadelphia Semiconductor Index is down 9 percent year-to-date.

Have earnings already peaked?

It appears that tech investors are starting to worry about slowing earnings growth in the second half of the year. Analysts are predicting earnings growth of 36 percent for the S&P technology sector in the third quarter and 22 percent in the fourth quarter.

While that's still a solid level of growth, it has made investors wonder whether tech earnings peaked in the beginning of this year, especially since an interest rate hike is widely expected in the near future.

"Investors are concerned about whether strong earnings will continue in light of rising rates," said Michael Cohen, director of research for Pacific American Securities. "There are worries about rising rates being a disincentive to continued business spending."

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That's a major fear because tech stocks did so well last year (the Nasdaq surged 50 percent) largely because of expectations of a sustainable recovery in corporate tech spending.

If it turns out that the surge in business demand during the first quarter and expected strength in the second quarter was just a blip, then that would be bad news for the tech sector.

With that in mind, Cohen said he expects tech stocks to tread water during most of the summer because it's unlikely that there will be any new evidence just yet to suggest that earnings for the second half will be stronger than expected.

In the coming weeks, more tech companies will probably give guidance about the second quarter. Intel, for example, is expected to revise its sales forecast for the second quarter on June 3. Analysts are currently expecting revenues of $7.98 billion, up 17 percent from a year ago.

Investors are clearly hoping that the midpoint of Intel's new guidance range will be above this level.

Profits peaking?
Tech earnings should remain strong but the level of growth is expected to slow.
Est. EPS Growth
1Q' 0468%
2Q '0456%
3Q '0436%
4Q '0422%
Full year '0519%
For S&P Technology sector. Data as of 5/21/04
Source:Thomson First Call

But even if Intel does issue a rosy forecast and other techs follow suit, will that be enough? Tobias Levkovich, chief U.S. equity strategist with Smith Barney, wrote in a report Monday that he doesn't think analysts will be able to keep raising estimates for tech stocks, and the market in general, enough to satisfy investors. And that could be another negative for stocks.

"If powerful upward earnings estimate revisions have not been able to drive equity prices higher, we suspect that downward momentum in such estimate revisions may cause further stock market weakness to emerge in the next few months," Levkovich wrote.

Tech needs to live up to high expectations

That could hurt tech stocks the most since valuations are still fairly high. The S&P Technology sector is trading at 23 times earnings estimates for the next four quarters, about a 40 percent premium to the overall market. Ken Perkins, an analyst with Thomson First Call, said tech stocks will need to keep beating estimates by a sizable amount in order to live up to these multiples.

"Earnings are going to have to really go up in order for valuations to look attractive. Tech earnings are going to be strong but it's already more or less priced into the stocks," Perkins said.

Tech stocks
Tech earnings
Interest rates

Perkins adds that because the second half of 2003 was such a good one for the tech sector, this will also make it tougher for tech companies to post stronger than expected earnings in this year's second half. And this will carry over into next year as well, he said, since the first half of this year has been extremely strong. To that end, tech earnings for 2005 are expected to be up 19 percent from this year.

"The deceleration in earnings growth is a significant concern. Techs are up against steep comparisons in the second half of this year and the first half of next year," said Perkins.

What's more, Levkovich said he's specifically worried about rising inventory levels in tech, particularly at chip companies. He wrote that this could eventually lead to excess capacity if demand tails off, which he dubbed "the next phase of difficult news for tech stocks to digest over the next few months."  Top of page

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