Is It Time To Worry About Tech?

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Summary

Are recent quarterly results a harbinger of poor things to come for the rest of technology?

Maybe not. The average tech company already reporting has beaten earnings expectations by 4.3 percent on an equal-weighted basis, suggesting the biggest names with disappointing results were outliers.

What felled the big guys? Wall Street's unrealistic expectations.

The bigger they are, the harder they fall. Tech investors learned that the hard way after Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) missed first quarter earnings expectations. Share prices for all three companies dropped in late April and have yet to return to their pre-earnings highs. Are the results a harbinger of poor results for the rest of technology? Credit Suisse says no.

For starters, the average tech company already reporting has beaten earnings expectations by 4.3 percent on an equal-weighted basis, suggesting that the biggest names with disappointing results were outliers rather than standard-bearers. What felled the big guys? Wall Street's unrealistic expectations. "It's obvious that the three IT majors have become a victim of too-high investor expectations rather than a weak sector trend," says Ulrich Kaiser, a senior information technology research analyst at Credit Suisse.

Indeed, Kaiser sees multiple investment opportunities, ranging from the success of companies using disruptive technology to upend traditional businesses to the potential of M&A deals, the volume of which rose 8 percent in the first quarter of this year, according to EY. Share buybacks and dividends, meanwhile, continue to bolster shareholder returns. In the last quarter of 2015, IT firms in the S&P 500 paid out $16.6 billion in quarterly dividends, second only to financials, and spent $33.2 billion on buybacks, more than any other sector, according to the research firm Factset.

Certain tech products and services, meanwhile, promise to drive continued earnings growth. A survey of U.S.-based chief information officers by Nomura Holdings last March found that most listed security, cloud computing and big data analytics as the top drivers of IT spending at their companies. Gartner predicts that while worldwide IT spending will see an 11 percent increase by 2020 from last year - from about $3.5 trillion to $3.9 trillion in 2020 - cybersecurity spending will more than double to $170 billion, up from $75.4 billion, over the same period. The growth in the big data market could be even more dramatic, with market research firm Wikibon forecasting that annual revenues from big data software, hardware and professional services will nearly triple from just under $23 billion to some $60 billion by 2020.

Cloud computing, in particular, has become a magnet for corporate spending as companies either build private clouds or use public clouds to access web-based software, known as software-as-a-service. When customers rely on public cloud-based services - instead of making one-time expenditures on tech projects - they provide recurring income for IT vendors. "These expenditures become regular payments, like installments, over at least a three-year time horizon," Kaiser said. "You get foreseeable revenue streams you can calculate and the churn rate is very low." The public cloud services market is expected to grow to $204 billion this year, up from $175 billion in 2015, according to Gartner.

Credit Suisse analysts expect software, in general, will see more IT spending than hardware, with the exception of one much-anticipated piece of hardware: Apple's iPhone 7, due to launch in September.

The weaker dollar has provided an additional tailwind for the IT sector. Most tech firms are based in the U.S. - 85 percent of MSCI World Information Technology Index calls the country home - and exports account for some 60 percent of sales. Credit Suisse attributes recent improvements in tech earnings momentum to exchange-rate movements, but it's unclear how long the supportive currency situation will last. The dollar surged last month and could rise further should the strength of the U.S. economy prompt a rate hike from Federal Reserve in the coming months.

A potential rate increase notwithstanding, Credit Suisse analysts expect a number of IT companies will see better growth and profitability by the second half of 2016. They also foresee a price-to-earnings multiple expansion ahead. Tech investors need not fret just yet.