NEW YORK (CNN/Money) -
After an 8 percent decline for the Nasdaq in the past five trading days -- and a near four-percent rout on Monday -- here's some more bad news for tech: Earnings estimates may be way too high.
That, of course, would make stocks even more pricey than investors now think. According to First Call, analysts expect earnings for technology companies to increase 35 percent. That seems unlikely, according to some market strategists.
Tobias Levkovich, institutional equity strategist for Salomon Smith Barney, says that earnings growth of 20 percent for technology is more reasonable. And Chuck Hill, director of equity research for earnings tracking firm First Call, thinks that earnings growth estimates for the S&P 500 will need to come down to about 12 percent from the current consensus of 14 percent... mainly due to cuts in technology estimates.
Analysts have already started to slash estimates for the S&P 500 for the first half of next year but have left the second half widely untouched, says Hill. According to First Call, on Oct .1, analysts were expecting earnings growth of 17.1 percent and 16.4 percent for the first and second quarters of 2003, respectively. Now, analysts are expecting 12.4 percent and 11.8 percent.
While these numbers might be attainable, there is another problem. Stocks have soared since the beginning of October even though earnings estimates have fallen. So even if earnings are expected to be better in 2003, many stocks already reflect this.
"I'm not worried about earnings, but there may be a limited upside for the market because of where valuations are," says Wendell Perkins, manager of the JohnsonFamily Small Cap Value and JohnsonFamily Large Cap Value funds.
|Sector†||Est. EPS Growth*†||P/E*†|
|†* Based on 2003 earnings estimates|
|†Sources: First Call, Baseline††|
The S&P 500 is now trading at about 17.3 times 2003 earnings estimates. That's not overly expensive by historical measures. But considering that the index was trading at 15.6 times 2003 earnings estimates on Oct. 1, when the earnings outlook was brighter, it's a cause for concern. Even if fourth-quarter earnings for this year are better than expected, stocks might not head higher on the news.
"There is a huge disconnect between the magnitude of what is likely to happen with earnings and what stocks have already discounted," says Richard Williams, strategist for Summit Analytic Partners, an independent research firm.
Sector by sector
Valuations for technology companies in particular have climbed to lofty heights. Cisco Systems, for example, has a P/E of 25 times calendar 2003 earnings estimates. And multiples for smaller technology companies are even higher. Cisco competitors Extreme Networks and Foundry Networks trade at 34 times and 37 times 2003 earnings estimates, respectively.
So even though there are still many concerns about overcapacity in the technology sector, most tech stocks have soared since the market's early October lows. Sound familiar? "This is a problem," says Hill. "This seems to indicate we haven't shaken out a lot of speculation that was present in the market in the late 1990s."
The basic materials sector, with expectations of 45 percent earnings growth, is another area where earnings projections might be too lofty, says Levkovich. He thinks that manufacturing activity will have to pick up much more than expected for the group to achieve this level of growth. Commodity prices are another big, and highly unpredictable, wild card.
But outside of these two sectors, other groups appear to have reasonable earnings projections. The financials, consumer cyclicals and consumer staples sectors are all expected to grow in the low double digits and trade in a range of 12 to 19 times earnings estimates. So these might be among the safer bets for investors going into 2003.
Perkins thinks health care is another area worth a look. Analysts expect earnings growth of about 12 percent in that sector and the group trades at about 19 times earnings estimates.