And say what you will about tech companies and the pressure they face each quarter to jack up earnings: they keep pulling it off.

October 26, 2017

4 Min Read

By Bloomberg

(Bloomberg) — They’re not rate sensitive or built on oceans of debt. Their money is mined through sky-high margins, a sign of sustainability. And say what you will about tech companies and the pressure they face each quarter to jack up earnings: they keep pulling it off.

Such is the mindset of bulls heading into another deluge of computer and internet company results, starting today with Amazon and Microsoft. Confidence has soared; so have the stakes. A ninth straight year of  gains in the Nasdaq 100 Index has pulled more money into tech ETFs than any other group and the trade was just described as the most crowded in the market by Bank of America for the fifth time in 2017.

To recap: U.S. tech companies have added more than $1 trillion in equity value this year, with gains from the five biggest accounting for one-third of the S&P 500 Index’s advance at various times. Hearts have beaten faster in recent days, with the storied FANG Block posting its worst run of down days this year in a market lately willing to punish anyone who comes up short.

“Let’s be honest, if these guys do miss and not make the numbers, there is no doubt they’ll be put in the penalty box,”  Jason Cooper, a money manager who helps oversee $4 billion in South Bend, Indiana, at 1st Source Investment Advisors, said by phone. “It’s one of the triggers that could get the ball rolling on the downside just because how much the FANG stocks have represented growth.”

Still, if you’re worried, consider the alternatives. Right now, companies in the S&P 500 Information Technology Index account for 24 percent of the overall index’s price, and 20 percent of its overall earnings. Twenty years ago, when the group made up 10 percentage points more of the benchmark’s weight, its earnings contribution was 5 percentage points lower than it is now.

And while the FANG stocks may be extended, valuations for the overall tech industry are nowhere near the bubble peak. Thanks to persistent profit growth, tech stocks trade at 19.2 times forecast earnings, in line with the S&P 500. At the height of the internet frenzy, the group traded at a 44 percent premium.

And yet a meltdown on par with the dot-com collapse is what investors are mainly concerned about. At Goldman Sachs, the most commonly asked question from clients is “When will the rally end?” Tech firms have inherited the mantle last worn by financial companies circa 2007, recently exceeding their share of the overall stock market. Where else would the market’s paranoia be focused but on their earnings?

Profit growth will be strong in the quarter — that’s all but settled. Analysts predict information technology firms will boost operating income 10.1 percent from a year ago, the most of 11 industries in the S&P 500 save energy companies. Growth is forecast to average about 15 percent a year through 2019, a pace crucial to maintaining price-earnings ratios hovering around 24.

And while the rest of the market struggles through an uneven season, technology firms have mostly skirted the volatility so far. Among companies in the industry that have reported, 90 percent exceeded analyst estimates, data compiled by Bloomberg show, with stocks climbing an average of 1.5 percent on the first day post announcement, better than any other group.

Still, it’s not enough to appease investors, many of whom were bruised in July when shares of Google and Amazon fell on the first day after reporting. A Bank of America index tracking the shares of Facebook, Amazon, Netflix and Google just fell for the sixth time in seven days, extending the group’s retreat since its October high to almost 4 percent.

For a group whose shares are up 40 percent year to date and valuations have expanded to about six times the S&P 500, it doesn’t take much for the uneasiness to surface. Some of the recent weakness in the FANGs may be attributable to analysts cutting estimates for the biggest tech firms while revising forecasts up for the rest of the market, data compiled by Bloomberg show.

Cooper’s firm owns Google and Amazon shares, and he said he’s ready to stick to them no matter what happened in their earnings this time.

“I’m willing to accept the good and bad,” he said. “I don’t want to go to other places at this point. The alternative is just not as good as what I already own.”

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