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The Chicken Little market
Investors are running for cover following some nasty warnings but are things really that bad?
July 7, 2004: 5:04 PM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - "The sky is falling! The sky is falling!"

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Sure, it's tempting for investors to start running around all Chicken Little-like after a series of ugly earnings warnings in techland this week. Conexant's bombshell sent chip stocks into a tailspin Tuesday.

And the news has been even worse in software. Storage software developer Veritas said that second-quarter sales and earnings would miss analysts' expectations Tuesday morning.

That was followed by a slew of warnings after the bell Tuesday from several smaller software firms, including Kana Software, JDA Software and FileNet.

Topping all that off, PeopleSoft lowered its second-quarter outlook Wednesday morning. Oh the humanity!

But investors should relax and take a deep breath. This latest spate of earnings warnings is actually not that bad. Really.

Earnings season should still be strong...

The headlines certainly haven't been pretty. But these high profile warnings are obscuring the fact that second-quarter earnings for tech companies, and the overall market, are still looking incredibly promising.

According to earnings tracking firm Thomson/First Call, there have been 341 second-quarter earnings preannouncements so far: 112 have been positive, 174 have been negative and the remainder were in line.

Same as it ever was
It may seem that there have been more tech warnings than usual lately but the pace isn't much different from last year.
Type of announcement % of total (2Q '03) % of total (2Q '04) 
Positive  27.7% 32.9% 
In-line 22.6% 16.1% 
Negative 49.7% 51.0% 
 Source:  Thomson/First Call

For the rest of the market, there have been 662 preannouncements: 235 positive and 333 negative.

So for the market as a whole, there have been about 1.5 times as many warnings than good news. For tech, that ratio is slightly higher, at 1.6. But both figures are historically quite low. Last year at this time, there were 82 positive preannouncements from tech companies and 147 warnings, for a ratio of 1.8

And John Butters, an analyst with Thomson/First Call, said that since 1996 there have typically been more than twice as many quarterly earnings warnings than positive preannouncements. That's true for tech and the overall market.

...but what do the warnings really mean?

Still, it's hard to blame investors for panicking. There has yet to be a positive earnings announcement from a tech bellwether such as Intel, Microsoft or Cisco that could change sentiment. So investors have little reason to focus on anything but the bad news.

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"When companies issue negative guidance, it really takes a toll particularly when investor confidence is fragile like it is right now," said Ozan Akcin, chief market strategist with Puglisi & Co. "Everybody out there needs to hear a lot of unequivocally good news."

Akcin said that what makes things more confusing for investors is that some tech companies may be just trying to talk down Wall Street, since analysts have started to boost their earnings estimates to what could be unreasonably high levels.

Veritas, for example, is still expected to report a year-over-year sales gain of about 16 percent in the second quarter. But that's down from Wall Street's consensus estimate of 20 percent growth.

"It does appear that companies are trying to manage expectations," Akcin said. "It's hard to really decipher what's really bad news."

Sunil Reddy, manager of the Fifth Third Technology fund, agrees that the most recent warnings are leaving investors, even professional ones, puzzled.

"Definitely some preannouncements make you pause and wonder what's going on," said Reddy. "Even though these are unique events, a lot of surveys show tech spending is just ok, not great."

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In particular, Reddy said that the Veritas warning has him a bit concerned. He said it's unclear whether or not Veritas is going to miss its numbers because of increased competition from EMC, which made several storage software acquisitions last year, or if it's a sign that corporate demand for software isn't as robust as people had previously thought.

Obviously, if it's the former, then that's probably just bad news for Veritas. But if it's the latter, that's not good news for the software sector or the rest of tech for that matter.

So the recent warnings, while troublesome on a company specific basis, are not yet a true bad omen for second quarter earnings season. But the earnings confession period isn't over yet.

"Overall, the preannouncement environment is still positive but if this round of warnings continues, that's a red flag," said Butters.  Top of page




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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.