With earnings season in full swing, we believe first-half 2010 corporate profits at many technology companies are shaping up to be a lot rosier than compared to last-year’s mid-year earnings cycle.
When it comes to beating consensus estimates, nobody does it better than Apple (AAPL). Lately, the company can’t do no wrong and continue to blow-away analyst forecasts. Their latest report was forty cents above estimates, for a nice 12.7% “surprise.”
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Notice that Apple’s share price rose in anticipation of earnings and continued its ascent after the announcement.
Intel (INTC) too for its part reported their best net income in a decade. Top-line growth, bottom line growth and for dessert... margin growth. Ironically, gross margins at AAPL fell 180 basis points in their latest report.
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However, when you compare their respective stock performances over the past month, low-beta INTC (1.14) has outperformed Apple (1.43) significantly on a relative basis.
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In technology services, Cognizant Tech Solutions (CTSH) just announced record earnings for their 2nd quarter ending June 30, 2010. The provider of business technology and consulting services noted strong spending across the board and around the world. Investors reacted warmly, sending shares up 10% during regular trading.
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In technology, we are seeing some loosening of purse-strings as companies upgrade systems and budgets open to spend on projects previously deferred or cancelled.
However, in the aforementioned three examples cited, only INTC saw solid increases in operating margins compared to the previous quarter.
We can hear Apple die-hards snickering already, but the apple-cart (no pun intended) could potentially get a bit top-heavy for Jobs and Co. should declines in gross margins become a regular occurrence. Yet, the stock remains a momentum darling and its products a cultural phenomenon. How long can this run last?
In the case of CTSH, we note a spike in accounts receivables and payables in their Q1 2010 report. View our Q1 analysis for CTSH here. While we have not seen all the Q2 numbers yet, our initial read from the 8-k released 8-3-10 indicates further weakness of revenue metrics and capital productivity in these areas during the latest period.
The bottom line for tech stocks is to focus on how these companies generate their cash-flows and earnings yield. Keep an eye on inventories, receivables, payables, etc. for clues to potential changes in earnings quality.
Keep tabs on days-sales outstanding. Rising DSO’s could be a sign that a company offered generous terms to book the revenue. Similarly, watch for increases in deferred revenues. If the sale of a product or service cannot be converted to true operating cash-flow during the current period reported, then accruals are likely boosting earnings. Healthy earnings quality is derived from paying customers, not accounting gimmickry.
Although our three examples do not speak for the entire technology complex, each of these companies has little or no debt, >30% cash-to-assets and strong balance-sheets.
But, we caution investors not to focus too much on year-over-year comparisons. Last year was crummy for everybody and it stands to reason that restructuring efforts played a big role this year’s earnings reports. Of course, top-line growth helps a lot too.
However, if tech spending is for real, then investors will want to pay very close attention to sequential quarterly comps for confirmation.
That said it would not hurt to take some profits in AAPL and CSFT. They’ve had a great run, but their stock prices may have gotten ahead of the fundamentals. You can always buy them again on a pull-back in price.
Why not buy some Intel? It might seem like a stodgy commoditized chip play to some, and anti-competitive to others, but INTC is the innovative leader in their space. We do note a spike in inventory levels and receivables in their Q2 2010 10-Q and an 11% bump in payables as compared to the prior quarter (see our analysis here).
However, INTC's earnings yield in the latest period are north of 8% and cash is about 31% of assets. Thus, we would expect the current 3% dividend yield to be secure for the foreseeable future. Get paid to wait.
Disclosure: Author is long INTC
