U.S. technology stocks, the second-best industry of the past decade, have fallen to the cheapest levels in at least seven years and are vulnerable to more losses as analysts reduce second-quarter profit estimates.
Earnings at computer companies will fall 5.5 percent in the three months through June as consumers and government agencies cut spending, according to more than 2,000 analyst estimates tracked by Bloomberg. The group, led by Apple Inc. (AAPL) and International Business Machines Corp. (IBM), trades at 13 times projected profit, the lowest level compared with the Standard & Poor's 500 since Bloomberg began compiling the data in 2006.
Bulls say the unprecedented discount means technology stocks, which tend to lead during expansions, are too cheap to pass up as the world economy grows. Bears say the shares will remain the worst-performing group in the S&P 500 (SPX) this year with companies and governments spending less on technology as growth weakens in Europe and China. President Barack Obama's proposed budget would reduce spending on information technology by $2.5 billion by 2015, according to Bloomberg Industries.
“I get the sense from a lot of managers that they're going to sit on their budgets until the end of the year,” Peter Sorrentino, who helps manage about $14.7 billion including shares of Google Inc. and Intel Corp. at Huntington Asset Advisors in Cincinnati, said in an April 24 phone interview. He sold Accenture Plc (ACN) and Apple shares last year.
“It is looking as though the economy is going to flatline for a while, after the disappointing numbers from China,” Sorrentino said. “There isn't a real catalyst here for ramping up production.”
The S&P 500 advanced 1.7 percent to 1,582.24 last week after better-than-projected earnings from Travelers Cos. and United Parcel Service Inc. outweighed data showing the U.S. economy grew 2.5 percent last quarter, less than forecast. Technology shares have underperformed the S&P 500 by 9 percentage points this year.
Of the 270 S&P 500 companies that have posted earnings this month, 74 percent exceeded analyst estimates, according to data compiled by Bloomberg. Rising corporate profits have helped lead the S&P 500 up 0.8 percent since the end of March, a shift from the past three years when the S&P 500 declined an average 15 percent after peaking in April. Futures on the index rose 0.3 percent at 8:48 a.m. in London today.
Companies from Accenture to Juniper Networks Inc. (JNPR) and Motorola Solutions Inc. (MSI) have predicted sales that trailed analyst estimates. The industry is 9.1 percent cheaper than the S&P 500, a bigger discount than seven of the nine other industries, behind only energy and financial stocks.
Apple, the world's second-biggest company by market value, posted the first profit drop in a decade and said sales would be lower than analysts estimated this quarter. While the Cupertino, California-based maker of iPads also said it would return $55 billion to shareholders through buybacks and dividends, the stock ended the week at $417.21, 41 percent below the peak reached in September.
The valuation fell to 10.4 times forecast earnings, the ninth-lowest in the industry.
IBM missed forecasts for the first time since 2005, sending its shares tumbling the most in eight years, as demand for hardware weakened and the company failed to sign customers to contracts. The world's biggest computer-services provider plans to spend $1 billion cutting jobs in the second quarter, when profits are projected to climb at the slowest pace since 2004, data compiled by Bloomberg show.
Shares of Armonk, New York-based IBM trade at 11.4 times projected earnings, cheaper than 78 percent of S&P 500 companies.
EMC Corp., the world's biggest maker of storage computers, said last week that it plans to buy back $1 billion in shares in 2013. The Hopkinton, Massachusetts-based company had reported first-quarter earnings that missed estimates as customers restrained spending. The shares are down 12 percent this year, sending the valuation to 11.7 times projected earnings.
Estimates show profits for the 70 companies in the S&P 500 Information Technology Index may shrink in the second quarter, according to a survey of analysts tracked by Bloomberg. The projection for a 5.5 percent profit contraction is down from an estimate for 7.2 percent growth at the start of the year, according to Bloomberg data.
For James Paulsen, who oversees $325 billion as the Minneapolis-based chief investment strategist at Wells Capital Management, the industry is a bargain. He predicts technology stocks will rally as companies use excess cash to repurchase shares. Paulsen's firm added to stakes in Salesforce.com Inc. and Cisco Systems Inc., according to a Dec. 31 filing.
“I'm as nervous about the large-cap tech growth stories as anybody, but I also think that they are getting to be really reasonable values,” Paulsen said in an April 24 phone interview. “There's a lot of extra spending to come. I think we may start to see some of that starting to emerge before the year's out.”
For contrarian investors, now may be a good time to buy. Computer shares have fallen 6.6 percent since reaching a peak in September, while makers of household goods and health-care stocks soared at least 14 percent. Technology, energy and financial stocks are the most inexpensive industries in the S&P 500 with multiples of less than 14 times earnings.
The U.S. government will spend less on information technology in the next three years, curbing revenue for companies from IBM to Oracle Corp. and BMC Software Inc., data from Bloomberg Industries and the U.S. Office of Management and Budget show. The budget deficit narrowed in March as spending shrank almost 21 percent during the first month of mandatory federal cutbacks known as sequestration. The $1.2 trillion in across-the-board reductions are spread over nine years as part of a 2011 deal to increase the U.S. debt limit.
IBM Chief Financial Officer Mark Loughridge said in an April 18 conference call that the company's U.S. federal business fell 13 percent last quarter, calling it a “drag on the U.S. performance.” F5 Networks Inc. said on April 4 that spending cuts dragged down government sales and forecast quarterly revenue that missed analyst projections. Shares of the company, which makes data-management equipment, have tumbled 24 percent this year.
Harris Corp., which sells communications equipment to the military, cut its profit and sales outlook for the year on April 11, citing delayed orders from U.S. agencies. Analysts forecast the Melbourne, Florida-based company will post the biggest profit drop since at least 2003. The stock has slipped 5.2 percent this month, to trade at 9.7 times projections.
Motorola, the maker of two-way radios and bar-code scanners, fell the most in more than two years after saying second-quarter profit and sales would trail estimates. The company is depending more on its government customers, which account for about 70 percent of revenue, as corporations defer orders, according to Chief Executive Officer Greg Brown.
“We saw customers delay or defer some key purchases” in logistics and retail in particular, Brown said in an April 24 interview. The price-earnings ratio for Schaumburg, Illinois- based Motorola fell to 15.5 last week, down from 17 earlier this month.
When technology shares outperform, the U.S. economy has seen bigger expansions. In quarters when the group rallied the most or second-most in the S&P 500, the U.S. expanded 3.2 percent, compared with the average of 2.4 percent since 1989, data compiled by Bloomberg show. The growth rate falls to 0.8 percent on average when computer shares trail the S&P 500.
GDP will increase 2 percent this year, down from 2.2 percent in 2012, according to the median of 80 economists' forecasts compiled by Bloomberg. Last quarter's 2.5 percent growth fell short of the 3 percent gain projected.
The International Monetary Fund has cut its outlook for global growth the past four quarters, and China's economy, the second-biggest in the world, expanded at a slower-than-forecast pace in the first quarter, helping drag commodities such as gold and copper into a bear market. Economists project Europe's GDP will contract for a fifth quarter in the three months ending in June, falling 0.3 percent after a 0.5 percent decline in the first three months of 2013.
Orders for U.S. non-defense capital goods excluding aircraft, a proxy for future business investment in equipment such as computers and communications gear, rose 0.2 percent last month, less than estimated and failing to make up for a 4.8 percent slump the previous month, according to a report from the Commerce Department April 24.
“Capital expenditures in corporate America, corporate China, corporate Europe, are what drive the technology sector profits, and that has just remained flat,” Chris Hyzy, who helps oversee about $325 billion as chief investment officer of U.S. Trust in New York, said in an April 25 phone interview. “Because Europe is in very bleak economic times and China's facing a slowdown, the tech sector is unfavorably harmed more than most sectors, if not the most.”
Juniper, the second biggest computer-networking equipment, forecast profit and sales below the average analyst estimate after reporting last week weaker sales to telecommunications providers and big companies. Chief Executive Officer Kevin Johnson said after last week's report that demand from government agencies and financial-services firms had also weakened. The shares fell 20 percent in 2013, sending the valuation to 13.4, the lowest since July.
Cisco said in February that weakness in China and Europe and lackluster government spending on networking equipment had slowed sales. The San Jose, California-based company, which cut 500 jobs last month, will post the smallest profit increase in six quarters when it reports May 15, according to analyst estimates compiled by Bloomberg. The shares, down 2.2 percent since then, trade at 10.2 times projected earnings.
“It has been nothing short of terrible in this space,” said Walter Todd, who oversees about $940 million as chief investment officer of Greenwood Capital Associates LLC in Greenwood, South Carolina. “We really need to see these downward revisions abate in the sector before you get sustainable outperformance.”