While stocks of technology companies have gotten hammered recently, forecasts for their earnings have risen, so the group is looking increasingly attractive, from Big Tech all the way down.
The Technology Select Sector SPDR ETF (ticker: XLK) is down just over 9% from its record high, hit in late July, mainly because long-dated bond yields have taken off. Higher yields make future profits less valuable in current terms, which means investors aren’t willing to pay as much for the earnings fast-growing tech companies are expected to pump out years from now.
As a result, valuations of tech companies have fallen. The fund is trading at just under 24 times the aggregate earnings its component companies are expected to produce over the coming year, down from almost 27 times in late July.
Meanwhile, the sector’s business prospects have been improving. In the past three months, just over 70% of analysts’ changes to their forecasts for profits at tech companies in the
S&P 500
have been increases, according to Citi.
Higher-than-expected earnings for technology companies such as Netflix (NFLX) have been the most recent source of optimism. All of the five tech companies in the S&P 500 that had reported third-quarter earnings through Friday turned in higher profits than Wall Street expected. Aggregate sales for those five were about in line with estimates, while earnings per share were about 6% higher than anticipated, according to Evercore.
That is a positive combination. If profits are well ahead of forecasts while sales are just a little better than expected, it means profit margins are coming in better than anticipated.
Strong earnings reports are on the way and “should be the catalyst to move the tech sector higher,” wrote Wedbush analyst Dan Ives in a research note last week.
While the market will hear from more tech companies that are set to report earnings this week, such as
Microsoft
(MSFT),
Amazon.com
(AMZN), and
Meta Platforms
(META), it isn’t difficult to find tech companies that have already raised analysts’ hopes.
Salesforce
(CRM) is one. Analysts have lifted their estimates for 2024 EPS by just over 4% in about the past three months, according to FactSet.
A key factor behind that has been the company’s ability to use artificial intelligence to enhance its products. Analysts at Morgan Stanley wrote this month that surveys of software customers show that Salesforce has increased its market share by a few percentage points in the past couple of quarters. The consensus view among analysts is that while sales won’t grow as fast at they have over the past few years, Salesforce can sustain low double-digit increases over the next couple of years, allowing revenue to hit $42.6 billion by 2025.
The company remains disciplined on costs, which indicates it can achieve that growth while still expanding profit margins. Analysts expect earnings per share to grow at just under 20% annually for the next two years.
That could make the stock look alluring, given that it is down about 15% from the 2023 high it hit in late July.
That type of story is making tech stocks, at large, look more attractive. It’s simple: Investors can get high profit growth at lower prices now. The S&P 500 tech fund, in aggregate, is expected to achieve mid-single-digit sales growth annually for the next couple of years, according to FactSet.
As margins increase, EPS can grow about 15% annually over that span, but the share prices have taken a dive. Long-term investors should be interested in tech.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
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