On Friday, tech bellwether Microsoft Corp. released a quarterly earnings report that was so bad that one analyst referred to it as “a comedy of errors” – kneecapping the stock by 11%.
Welcome to “earnings season,” the rush of quarterly financial reports that, four times each year, can make or break individual stocks.
But this season is different.
Over the next three weeks, the tech-stock rally that has helped push the U.S. stock market to new record highs faces an intensely critical test.
The fact is that we are now more than four years into a bull market that has seen stock prices more than double from their 2009 lows.
Let’s be clear: Four years is one heck of a long time for a market to rally without experiencing a major correction. So the sales, profit and forecast reports that we’re going to see this week – and in the two weeks that follow – will likely tell us if the rally continues from here … or begins to weaken.
So today I’m going to show you exactly what to look for and how to analyze what you find.
And I’m even going to tell you about the one tech stock you need to watch. And I’ll also show you how to play it …
Under the Microscope … Under the Gun
Let me tell you a secret about earnings reports. Most investor’s think these quarterly corporate tell-all sessions are just about profits – you know, the proverbial “bottom line.”
As the Microsoft experience demonstrates, during jittery stretches like this, everything goes under the microscope – Citigroup analyst Walter Pritchard called the software giant’s earnings report a “comedy of errors.” Pritchard cited a laundry list of disappointments, including a revenue result that was $820 million less than the consensus estimate, putrid sales of the company’s “Surface” tablet, and a $900 million inventory write-down.
“Everything that could have gone wrong, went wrong,” Pritchard said.
Generally speaking, however, the investors and analysts who scour these reports will be studying three things: Revenue (sales), profits and “guidance” – the look forward that’s essentially a company’s prediction of what to expect in the months and year or so to come.
Guidance can be key: A company can deliver on revenue and profit, but if guidance is light, or worrisome, the stock can get clobbered (which makes sense, if you think about it, because that’s the look forward, and stocks are “forward looking” themselves).
But all three of these – sales, profits and guidance – depend on growth. And because tech firms are generally high-growth vehicles anyway, I believe that puts the tech sector front and center as this crucial earnings season progresses.
Tech stocks are front-and-center in our strategy aimed at helping you create wealth – and for a very good reason. Cyclical stocks – those tied to the U.S. or global economic cycle – aren’t going to get it done for you.
You only have to look and see how weak the U.S. economy actually is – and how persistently high unemployment has remained – to see why we feel this way.
On Monday, The Wall Street Journal estimated that the American economy grew at a tepid 1.5% rate in the first half of this year. I’ve been analyzing stocks and the economy for more than 30 years, and I tell you with great confidence that this is roughly half the pace we should be setting at this stage of an economic recovery.
The fact that growth is so low is a key reason that profits aren’t much better than they are.
The wild card in this is the U.S. Federal Reserve. The American central bank has signaled its intent to slow down money growth. With that in mind, earnings in the April-June period will give us a sense of how well companies can do without the Fed running the printing presses 24/7.
If there’s one sector that can produce solid financial results in the face of such weak macro growth, it’s high-tech. In fact, this slow-growth backdrop actually works to the tech-sector’s advantage.
Economists refer to it as “productivity.” But you probably think of it as “doing more with less.”
Simply stated, in a slow-growth environment like this one, companies that want to maintain or even grow profits have to do more with the same number, or even fewer, employees.
To make that happen, companies have to find some mode of assistance that makes up the difference.
And that’s just what technology does.
So companies invest in that technology. They invest in an array of tech platforms – smartphones, tablet computers, Big Data applications and cloud computing – that make each worker more productive.
If you think about it, each of those are the investable trends that we’ve been telling you about for months – the Mobile Wave, the Cloud, Big Data and others. And there are new ones developing – including the so-called “Internet of Everything,” which is destined to become a very big deal in the tech-investing realm.
A Note of Caution
Because there are so many firms that report their results during earnings season, investors look for a way to make the analysis easier. And they do this by choosing “representative” firms that are known as “bellwethers.” This isn’t just in tech – it’s true of every sector.
But when you use bellwethers as a proxy for an industry report card, you have to be careful.
And that’s especially true with tech, which as we’ve seen is undergoing massive – and fast-paced – changes.
Take Microsoft, which is actually a great example of why bellwether generalizations can be dangerous. Indeed, I’m telling you flat out not to make too much of the software heavyweight’s poor results.
Microsoft missed both profit and sales projections, which is the kiss of death in this volatile market. But I believe MSFT’s problems are self-inflicted wounds that stem from a series of bad decisions by CEO Steve Ballmer, who should have left long ago.
Microsoft, you see, is an “old” bellwether.
And we’ve found an array of “new bellwethers” that we use to assess the health of the global tech sector.
For instance, if you want to get a truly accurate feel for the health of big-cap tech firms, take a look at Google Inc. (NasdaqGS: GOOG). That’s because Google reaches well beyond its search-engine business and the related advertising it generates. Google is involved in cloud computing, which is hosted data services, and is a huge play on the mobile wave. And that’s just the beginning – there are lots more we could talk about with the company’s business.
Overall, Google had a very strong quarter. Last week, it reported a 20% increase in sales in its core business. And for the second quarter in a row, it reported a 16% rise in profit.
At first, the stock fell because investors worried about a 6% decline in prices for Google advertisements. But investors soon realized that Google more than made up for the price drop with a 23% higher sales rate compared to the year-ago period.
By the close of Monday’s session, the stock was just 1.5% shy of the 52-week closing high of $924.69 that it set back on July 15.
Google also gives us a great look at the strength of the mobile revolution…
It only launched its Android mobile operating system in late 2008. But Google is now the smartphone-segment leader, and is ahead of rival Apple Inc. (NasdaqGS: AAPL) – which is one of the key reasons that Apple shares remain down about 30% from a year ago.
Google says it has activated 900 million total Android devices. That’s heady stuff.
But get this: An additional 1.5 million Android devices are being turned on each day.
Given Apple’s decline, had Google shown weakness in the mobile arena, that would have been cause for concern. This would have told us that the mobile sector was weakening at a time when it should still be leading the tech industry forward.
Instead, we know that our belief in the Mobile Wave remains sound, meaning that sub-sector remains a place to fish for profits.
And we’re not basing that conclusion just on Google. Here at Money Map Press, “drilling down” to make sure we’re correct is standard procedure. And we also have a mid-cap Silicon Valley firm that underscores the real strength of mobile devices. With a market cap of $15 billion, SanDisk Corp. (NasdaqGS: SNDK) makes the flash memory drives used by nearly every major handset and tablet maker.
Actually, SanDisk gives us a look at three key sectors in one stock. Besides its mobile offerings, SanDisk also supplies the solid-state hard drives used in the data centers that enable cloud-based offerings to operate correctly. And SanDisk’s memory devices are found in a laundry list of consumer and business electronics.
That’s why I was so happy to see that SanDisk said its second-quarter sales were up 43% to $1.47 billion. Earnings per share quadrupled to $1.21 a share from last year second-quarter earnings of 21 cents a share.
So the Mobile Wave remains healthy.
In the meantime, it’s also important to keep a sharp eye on another area of tech – another area that we’ve talked about extensively, and one that’s poised to have a massive impact on many parts of the economy in the years to come.
I’m talking about Big Data.
The One Stock to Watch
Simply stated, the term “Big Data” refers to technologies that take the massive data sets that were formerly unusable or inaccessible – and make them viable for analysis and use in decision-making. The Big Data makes use of ultra-fast computers and software that can be used to reduce energy use, help solve crimes and unravel the mysteries of complex diseases.
Once again, a focus on the wrong “bellwether” could cause investors to come to the wrong conclusion about the investment viability of Big Data. Indeed, some investors may fear the field is slowing down. After all International Business Machines Inc. (NYSE: IBM) reported weak second-quarter results. Net income fell 17% from the year-ago quarter to $3.2 billion.
That’s a pretty lousy result. But if you really know what to look for, you can see that IBM isn’t really a Big Data bellwether.
IBM touts its capabilities in this sector. But the truth is that it’s been losing ground to smaller, faster and more-nimble companies..
And one of those companies is the one that I referenced at the outset of today’s Strategic Tech Investor column as the “one you need to watch.”
That company is the Fremont, Calif.-based Silicon Graphics International Corp. (NasdaqGS: SGI), which sells the ultra-fast computers and networking gear that organizations need to crunch through massive amounts of data.
SGI’s high-performance products power such applications as design for aircraft and autos, modeling of new drugs, weather simulation and data analysis.
With a $620 million market cap, the stock trades at around $18.35 a share.
Investors must expect a good earnings report – the stock is up 24% in the past month. And Needham & Co. just issued a new 12-month price target of $22 a share.
But the potential upside is much, much higher.
Here’s why. SGI’s management team price has been working to engineer a turnaround, so the longer-term gains could be much higher: After all, over the last three years, SGI has averaged a growth rate of 31%.
But the company’s next earnings report – due Aug. 5 – will be key. SGI is on a fiscal (not calendar) year, meaning this report will represent the financial results for its fiscal fourth quarter.
So in just about two weeks, we’ll have the company’s quarterly and annual results for earnings, profits margins, cash flow and sales. And I’m sure those financial results will also be accompanied by a management commentary on what lies ahead for SGI.
If you’re inclined to move into SGI now – before it reports earnings – here’s a tip on how to establish your position with as little risk as possible. As Microsoft demonstrated, when you’re this close to earnings, if the firm disappoints, the stock will get hammered – especially in a market as jittery as the current one.
So, in a case like this, the smart thing to do is enter a smaller buy order – perhaps as little as one-fourth your standard investment amount (or one quarter of the position that you ultimately hope to establish).
That way, if the firm misses forecasts and the stock gets slammed, you’ve already reduced your downside risk by making a smaller play (and you can potentially use such a decline to add to your position).
At the same time, by at least having some shares of SGI, you’re in a position to profit from any rally that ensues should the company’s earnings beat Wall Street estimates.
Armed with all these insights, let’s settle down and watch this earnings season unfold – together.
Rest assured that I’ll report back with any developments I think you need to know about – as well as any profit opportunities that this earnings season helps create.
In the meantime, I’m working on a new recommendation that I expect to have for you very soon.
It’s big … and it’s also surprising.
[Editor’s Note: Your feedback is very important. As always, I welcome your comments, questions, suggestions, and opinions. Post a comment below … I look forward to hearing from you.]