Big tech gets hit on earnings

The top US technology companies, whose growth has by far outpaced the growth in the economy over the past decade, took a beating last week as their latest quarterly earnings proved less resilient to the economic downturn than investors had hoped. Once the market’s highflyers and Wall Street’s darlings, these tech giants seem to be falling out of favour at the moment, as other sectors are leading the latest market rebound.

Among the mega tech companies reporting last week, Amazon shares sank by around 7 per cent on Friday after the company gave a disappointing fourth-quarter forecast. That proved to be a major concern as this is the big shopping time of the year.  

Earlier in the week, Alphabet reported a 27 per cent drop in quarterly profit, which sent the shares tumbling by around 8 per cent by the end of the week. This was the third quarter in a row that earnings declined over the previous year and the company missed expectations.  

In the meantime, Meta Platforms saw its shares plunge by almost 25 per cent after revenue dropped for a second quarter. The company also said it would pump more money into its metaverse initiatives next year. It’s hard to believe, but Meta is down a whopping 70 per cent this year, taking its market cap below $300 million for the first time in almost seven years. 

Elsewhere, Microsoft did beat on the top and bottom lines but missed on revenue forecasts for its cloud divisions and lowered its forward-looking guidance. This was on the back of an expected decline in PC sales and the dollar’s strength, sending its shares down 6 per cent by the end of the week.

The remainder of the so-called FAANGM group (an acronym referring to Facebook, Amazon, Apple, Netflix, Google, and Microsoft) fared a bit better, with Apple unquestionably the big winner last week, gaining more than 8 per cent on Friday after reporting results the night before. It was another record quarter for sales at $90.1 billion, and net income also came in at an all-time high of $20.7 billion. The iPhone still makes up about half of the company’s sales, generating $42.6 billion in revenue. That’s 10 per cent higher than last year, which was a little bit below expectations, but Wall Street was pleased with the overall numbers and the company’s strength in tough economic conditions.

Finally, Netflix also surprised markets to the upside when it released third quarter results the previous week after a big bump in subscriber numbers sent the shares rallying by over 13 per cent on the day following the announcement. The shares have recovered more than 50 per cent over the past six months but are still down another 50 per cent since the start of the year.

The combined market valuation of this group of companies peaked at the very end of 2021 at $10.2 trillion and at that point represented over a quarter of the S&P 500 by value. From the end of 2012 to the end of 2021, the value of this group grew by 10 times, at an annual growth rate of 28 percent. Over the long term, the equity market has grown by about 10 per cent per annum including dividends. Tech shares crashed in 2022, with the value of this group falling by over 30 per cent to date, which is about double the rate of the rest of the US equity market.

Consensus estimates for the tech sector for next year’s earnings have fallen by around 8 per cent from their peak but the majority of the reduction has come from the over 20 per cent lowering in estimates for the semiconductor industry group. Further estimate cuts are expected over the next year in semiconductors due to weaker growth in autos and industrials. Increased headwinds are also expected for software, hardware and services on the back of lower consumer demand both domestically and abroad, and a stronger dollar.

The IT sector is heavily exposed to overseas markets and hence remains vulnerable to a stronger US dollar. In effect, the IT sector has the highest global exposure of all S&P 500 sectors, with more than 58 per cent of revenue coming from outside the US, compared with 40 per cent for the S&P 500. While the US Dollar Index is down roughly 3 per cent from its peak at the end of September, it is still up around 15 per cent year-to-date. Tech is also most vulnerable to rising interest rates since this reduces the present value of more distant profits that are discounted at higher rates.

After more than a decade of expanding valuations, the sector’s price-to-earnings ratio has declined by 33 per cent from 29 times to 19 times, compared to a decline of 26 per cent for the S&P 500. IT shares are today much cheaper than they were in 2020 and 2021, but that does not necessarily mean they are attractive, as the sector still trades at a 21 per cent premium to the broader market.

Disclaimer: This article is brought to you by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd, which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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