NEW YORK (CNN/Money) -
Expectations for the technology sector are growing more optimistic by the day.
According to First Call, analysts are predicting third-quarter earnings growth of 75 percent for the S&P Technology sector, up from 57 percent just three weeks ago.
Are these projections reasonable or just more pie in the sky "guesstimates" from overly optimistic Wall Street analysts? It is starting to look like the numbers, as lofty as they seem, might be doable.
Recovery evidence is slowly mounting
Dell reported a strong fiscal second quarter two weeks ago and upped its sales guidance slightly for its third quarter, which ends in October. Last week, Network Appliance (NTAP: Research, Estimates) issued a bullish forecast for its fiscal second quarter, which also ends in October. And on Friday, Intel issued a surprisingly upbeat sales outlook for the third quarter, raising its guidance significantly.
Tech kingpins like Intel have weathered the tech downturn better than smaller rivals, mainly due to tight controls on costs and market-share gains. Overall sales growth has been relatively anemic.
But Intel said on Friday that it now expects revenue growth of about 16 percent from a year ago, as demand slowly picks up for traditional desktops and remains strong for newer wireless laptops.
Ted Parrish, co-manager of the Henssler Equity fund, said that Intel's good news was a big positive for semiconductor firms. As such, he thinks Texas Instruments will also raise its guidance, possibly at its mid-quarter update scheduled for Sept. 9. Analysts currently expect a slight earnings decline from a year ago and a revenue increase of 6.8 percent.
In his fund, Parrish owns shares of Microsoft (MSFT: Research, Estimates), Dell (DELL: Research, Estimates), Intel (INTC: Research, Estimates), Texas Instruments (TXN: Research, Estimates) and Applied Materials (AMAT: Research, Estimates).
Chip stocks have the most momentum heading into the third quarter. Communications chip firm Broadcom (BRCM: Research, Estimates) upped its sales guidance for the third quarter last week as well. And according to a breakdown of several Dow Jones tech subsectors by First Call, semiconductors are expected to post by far the largest gain in earnings, with analysts predicting a 155 percent jump.
But earnings growth is not expected to be as robust for other parts of tech. Software companies, for example, are only estimated to post 6 percent earnings gains from a year ago.
Chip companies typically lead tech recoveries, followed by hardware and then software.
Tech stocks getting pricey
Such outsized growth this quarter is of course helped by the fact that last year's third quarter was weak. "The base was set pretty low last year," said Parrish. "Tech will meet their numbers in the third quarter."
So the big question for investors now is whether a solid second half is already factored into tech stock prices. The Nasdaq is up more than 32 percent year-to-date and hit a 16-month high on Thursday. The S&P Technology sector trades at 29 times forward earnings estimates for the next four quarters, which is not cheap.
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| | Sector | | Est. 3Q EPS Growth | | Semiconductors | 155% | | Tech services | 31% | | Computers | 27% | | Hardware | 27% | | Software | 6% |
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* based on Dow Jones sector indexes | Source: First Call |
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Todd Campbell, president of E.B. Capital Markets, an independent research firm catering to institutional investors, said that because of this runup, there might be some pullbacks in the sector in the near term but nothing overly nasty as long as more companies give better-than-expected outlooks for the quarter.
"Tech earnings are improving, and the reality is that stock prices always move ahead of fundamentals. That's what they do. They are predictive instruments," said Campbell.
Parrish isn't expecting a major move downward for the sector either but said that tech companies probably won't head much higher until investors have some confidence about what 2004 will be like.
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So the key to the upcoming third-quarter earnings season will be if executives indicate whether the recent increase in demand is sustainable or just the normal second half of the year budget flush.
"Tech has had a great run, but it's going to take good first quarter of 2004 forecasts to justify the stocks going higher," Parrish said.
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