SMARTMONEY.COM: Techsmart: Techs Face Tough Earnings Season

Apr.07, 2008 in Market Outlook

Last Update: 4/4/2008 6:55:09 PM

By Dan Burrows
Of SMARTMONEY.COM

Earnings season is upon us again and there is little reason to think it will be
pretty. One of the last things investors in technology stocks want is a repeat of
the prior quarter, when profits were the strongest they have been in years but
the market shrugged off good news and severely punished the slightest misstep or
hint of caution.

Recent history should make the next few weeks very interesting, and not in a good
way. Tech sector earnings rose 26% in the fourth quarter, according to Thomson
Financial, the best showing since 2004, but the Nasdaq Composite Index responded
by disgorging 14% through the first three months of the year. Never mind the
profits; stocks are forward-looking and what they foresaw was recession.

Before the month is out we will hear from Google (GOOG), Apple (AAPL), Microsoft
(MSFT), Intel (INTC) and eBay (EBAY), to name just a few. With first-quarter
growth forecasts for tech sector earnings at just 9% and companies forced to
factor recession into their outlooks, this reporting season is shaping up to be
deja vu all over again.

“If there’s one positive it’s that we’re pretty much past the earnings warnings
period and we didn’t see too many,” says Darren Chervitz, director of research at
the Jacob Internet Fund. “But the key is going to be guidance and the keyword
there is going to be ‘cautious.’ Management is not going to stick its neck out
when the environment is so uncertain.”

At 20-times forward earnings, the Nasdaq’s valuation screams bargain. And even
though the market expects Street estimates to come down, Chervitz still thinks it
is oversold. But that doesn’t mean he is bullish. “The environment calls for
taking profits if you get them and not being greedy,” he says. “I still think
there’s a much higher potential for the market to be at a lower level in the next
few months than at a higher level.”

Another way in which the current earnings season will resemble the last one is in
the market’s neurotic sensitivity to every daily data point, says Karl Mills,
manager of Counterpoint Select Fund. “I think you’re going to see a lot of strong
reactions to specific news,” he says, pointing to Thursday’s blow-out report by
Research in Motion and a downgrade of Cisco Systems as examples.

“RIM’s news probably doesn’t warrant that kind of upward price movement and the
Cisco news is probably not as bad as the downward price movement tells you,” he
says. “But our broad outlook is we like tech, because companies like Cisco,
Microsoft and Intel have strong balance sheets, lots of overseas sales and are
positioned to participate in global growth.”

Those names aren’t only relatively defensive, but they are poised for
outperformance once the market anticipates an end to the recession. “They may not
go up very far in the near term, but when the lights do come back on we think the
price you are paying for growth on these quality assets is pretty good,” Mills
says.

Of course, big companies with strong balance sheets and lots of overseas revenue
have been the mantra for tech investors all year, and with the exception of
International Business Machines (IBM), it hasn’t really worked out that well.
Intel, with dominant market share and more than 70% of revenue coming from
abroad, is just one frustrating example.

“Intel was crushed on its last report but it really wasn’t that bad, not by a
long shot,” says Michael Church, a portfolio manager with Church Capital
Management. “If you said anything less than that you tripled earnings it was just
an ugly situation to be a company reporting in that mid-January time frame. But I
still feel that the Intels and Ciscos of the world continue to be strong, and I
think you use this time to your advantage.”

If there is any good news it is that at least some of the recession has been
baked into share prices already. And although the Nasdaq will likely remain
range-bound, it is out of bear territory and has regained a level last seen in
early February. “I think sentiment is improving but it is going to be a
challenge,” Church says. “I don’t think we’re going to have a rip-roaring rally,
but I do think we’ve marked a line in the sand.” As we head deeper into the
summer and the stimulus package and recent injections of liquidity come online,
the market might start to inch higher by year’s end, Church adds.

Until then, use this time to get great companies at a better price. With all eyes
focused on guidance relative to expectations and management having no good reason
to be aggressive, it is likely to be another tough earnings period. Don’t get
greedy. Take profits where you can. And keep long horizons. You won’t get rich
that way this season, but you won’t get indigestion, either.

-For more information and analysis of companies and mutual funds, visit
SmartMoney.com at http://www.smartmoney.com/

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