Big Week For Tech

by: David Silver

This is going to be a big week for the technology sector as Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) are scheduled to release financial results for the current quarter. AAPL is scheduled to release its third quarter results following the closing bell on July 24, while Facebook is scheduled to release its first quarterly results as a publicly traded company on Thursday, July 26 after the market closes.

Last week saw some behemoths in the tech industry surpass expectations and lead a strong week. Intel (NASDAQ:INTC), IBM and Google (NASDAQ:GOOG) surpassed expectations, while Microsoft (NASDAQ:MSFT) reported its first quarterly loss in more than 20 years; however, excluding goodwill charges, the company beat expectations. INTC and IBM alluded to strong tech spending despite the weakness in the U.S. and Europe. Google reported a surge in the top line following its acquisition of Motorola Mobility for $12.5 billion back in May. The strength of these stalwarts propelled to the Nasdaq to a 2% gain last week. Now the baton is passed to Apple.

Apple's past two earnings reports have been nothing less than jaw dropping. As a result, the stock is up almost 50% year to date, while the Dow Jones Industrial Average is up just 4%. Back when Steve Jobs was captain of the ship, the Company did a great sales job on Wall Street. Alec Baldwin from "Glengarry Glen Ross" would have been proud; under promise and over deliver. The company would release earnings that surpassed expectations, but management would try to temper the Street's estimates moving forward and give guidance that fell below what the Street was expecting. Estimates would come down and three months later, voila, results would surge past expectations. Rinse and repeat.

The Street is expecting earnings of $10.36 per share for the third quarter on revenue of $37.2 billion, which compares with earnings of $7.79 per share in the third quarter of 2011. A large driver of Apple's results is the iPhone, which accounts for nearly half of revenue. However, with the supposed launch of the new iPhone 5 coming soon, there are concerns that many people will wait. I will admit I am one of those people; however, each new version of the iPhone was met with the same skepticism and estimates still blew away expectations. Analysts are expecting 29 million sales of iPhones, yet AAPL sold more than 35 million new iPhones during the first three months of 2012 (despite the buzz about the iPhone 5). Earnings estimates have increased approximately 4% over the past three months, while the stock increased almost 6%. The company is trading with a trailing twelve month PE ratio of 14.98, compared with the industry average of 13.07. However, despite the 50% appreciation year to date, the stock is still trading at the low end of its five-year PE range of 14.61. For comparison, over the past five years, AAPL's PE ratio has ranged from 14.61 to 39.05. Looking towards to the future, AAPL has a forward PE ratio of 11.10 and a PEG ratio of 0.58. The lower the PEG ratio, the more undervalued a stock is supposed to be.

I am a big fan of AAPL products; I have an IPhone, I am typing this article on my MacBook pro, I am looking at purchasing a new iPhone 5 when it is released, and an iPad as well. However, what worries me about the stock is the hype around it. AAPL apparently can do no wrong, but what happens when there is no new segment to create? AAPL pushed the envelope with the iPod, made the smartphone the next must-own item, and then basically created the tablet segment with the iPad. Where does the next level of growth come from? With Steve Jobs at the helm, there was the sense that anything was possible. Despite wearing a similar black shirt and jeans at conventions, CEO Tim Cook hasn't wowed me yet. He took over the reigns of a great company with a ton of cash and a strong pipeline and kept it as a great company with a ton of cash, but not a great deal of insight into its pipeline. One could argue that it was the same with Jobs; however, the difference is Jobs earned the benefit of the doubt. Cook needs to earn that before I give him the same latitude.

That being said, I am looking for a strong beat from AAPL. Despite the weakness in Europe, and the U.S., I expect iPhone sales to top 30 million, with iPad shipments above 19 million, and Mac shipments being strong as well. The Street has modeled for revenue of $37.2 billion; my forecast is for $40.6 billion and earnings of $11.12 per share (the Street is modeling for earnings of $10.36 per share).

The next big tech name is Facebook, which releases earnings on Thursday, July 24. Let's be honest, the company needs some good news. After IPOing on May 17 at $36, shares of FB tumbled to a 52-week low of $25.52 and were marred by controversy surrounding some Wall Street shenanigans taking the stock public (too many shares, too expensive etc.). However, the social networking giant has its chance to quiet the non-believers (I am one of them) as it reports earnings for the first time as a publicly traded company.

Facebook trades with a PE ratio of 92.74. That equates to FB being five times more attractive than AAPL as an investment. SAY WHAT!?!?! PE ratio measures the sexiness of a stock, while its PEG ratio is 2.09 (the lower the better). Strictly on a valuation basis, if FB traded with a PE ratio of the average tech company in the space (17.91) and given the $0.31 per share of earnings over the past twelve months, FB would need to trade at $5.55. The Street is expecting earnings of $0.12 per share on revenue of $1.15 billion. Revenue estimates range from $1.06 billion to $1.29 billion.

For FB, the question becomes from where does the growth come? Just about everyone and their mother has a Facebook account; even my mother has one. The main product is being given out for free, so the growth comes from the advertisements? I do not think I have ever clicked on a link on the side of my Facebook page. The average click-through rate (CTR) of an ad on the Google Display Network is 0.4% - almost 10 times as high as the typical Facebook ad. Average CTR on Facebook is under 0.05%, about half the industry average for online banner ads. At the same time, costs per thousand impressions on Facebook are climbing. The Facebook CTR is actually falling as it was 0.063% in 2009, showing that while common market thought is that the company will improve in targeting ads, empirical evidence shows that the company is actually becoming less effective.

Earnings estimates for the current year has fallen almost 8% over the past 60 days to $0.52 per share, while earnings for 2013 have remained constant at $0.65 per share (a 27% growth rate). I would be avoiding FB into earnings this quarter. If the stock pulls a rabbit out of its hat, then there will be a lot of shareholders looking to take profits into strength and a buying opportunity will follow that; there is no need to chase the stock. That being said, I do not think that FB really puts up a good quarter, and more importantly, I expect the coming quarters to be potholed with questions and concerns.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.