NEW YORK (CNN/Money) -
Even a tech stock bear would have to admit it's getting better when it comes to tech earnings.
Excluding Lucent, which skews results due to its massive loss a year ago, the 60 techs in the S&P 500 that have reported third-quarter results so far have posted earnings growth of 26 percent from a year ago, according to First Call.
“ To sustain these valuations, we need a strong first half of 2004 and that's an open question. ”
John Rutledge
Evergreen Technology fund
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What's more, revenue growth was 7 percent, the highest year-over-year change on the top line since the second quarter of 2000.
Considering that many tech companies were posting earnings gains earlier this year that had more to do with cost-cutting than with increasing demand, this level of sales improvement should be viewed as a welcome sign.
"Earnings were extremely robust," said Sunil Reddy, manager of the Fifth Third Technology fund. "The bottom line is that people who doubted that the earnings acceleration would continue have been proven wrong."
(For a look at key earnings reports in the tech sector, click here).
So why no earnings induced rally?
Still, since tech earnings season began in earnest with Yahoo!'s (YHOO: Research, Estimates) report back on Oct. 9, the Nasdaq has been stuck in a narrow range. And some companies that reported better-than-expected results, such as Microsoft (MSFT: Research, Estimates) and Amazon.com (AMZN: Research, Estimates), are trading lower than they were before they announced their latest earnings.
What's the problem? A strong third quarter wasn't exactly a huge shock to investors. The Nasdaq had surged 43 percent between the beginning of the year and Oct. 9, after all.
Reddy said that some of the more short-term-oriented momentum investors may be locking in some profits from tech stocks, and that has limited the upside for the sector even though the fundamentals were good.
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| | | | EPS Gr. | | Q1 2003 | 17% | | Q2 2003 | 20% | | Q3 2003 (as of 10/29) | 26% | | Q4 2003 (est.) | 31% | | Q1 2004 (est.) | 34% |
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* year-over-year change for tech companies in the S&P 500, excluding Lucent | Source: First Call |
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But a solid fourth quarter might already be priced into tech stocks as well. Once again excluding Lucent (LU: Research, Estimates), analysts are expecting fourth-quarter earnings for the tech companies in the S&P 500 to increase 31 percent from a year ago, with sales up 8 percent.
"The problem is that the stocks have run so much this year that valuations are stretched. To sustain these valuations, we need a strong first half of 2004, and that's an open question," said John Rutledge, manager of the Evergreen Technology fund.
Specifically, semiconductor stocks could be due for a pullback as investors digest their strong results. Intel (INTC: Research, Estimates) and Texas Instruments (TXN: Research, Estimates), for example, both reported sales and earnings for the third quarter that far exceeded expectations and both gave rosy fourth-quarter outlooks.
Intel and Texas Instruments have continued to soar since their latest earnings reports. Intel hit a new 52-week high Wednesday and Texas Instruments is trading just 2 percent off its 52-week high.
A look at key tech earnings
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The chip sector has been among the hottest areas in tech this year. The Philadelphia Semiconductor Index has surged 70 percent year-to-date thanks to the improving fundamentals. But that has led to concerns about how much longer this run can last.
Chip companies, particularly those who are benefiting from seasonal pickups in consumer gadgets such as computers and cell phones, probably need to show that next year will also be a good one in order to justify current stock prices.
"Semi stocks won't do anything until we get guidance about estimates for 2004. Otherwise, the stocks will get really overheated," said Ted Parrish, co-manager of the Henssler Equity fund.
Techs need to deliver in '04
For now, analysts are expecting that the recent strength in tech earnings will carry over into the beginning of next year. The estimated earnings growth for the first quarter for S&P 500 tech companies is 34 percent, excluding Lucent.
The Evergreen Technology fund's Rutledge said that 2004 estimates are contingent on corporations finally starting to spend more on tech, and he's not convinced that there's enough evidence of that yet. "Consumers are coming through nicely but it doesn't look like there are major plans for corporations to ramp up IT spending in 2004," said Rutledge.
So while it's probably a bit of a stretch to say that tech investors are going to ignore the fourth-quarter results, it does seem safe to say that between now and January, investors will probably be more interested in clues about how the first half of next year is shaping up.
"The issue is earnings sustainability," said Rutledge.
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