Stock Market: Better Than Expected Results Push Tech Rally
Financial expert Gordon Pape looks into the recent turnaround for tech stocks. Photo: A. Martin UW Photography/Getty Images
After being battered last year, 2023 is turning out to be a pretty good year for tech stocks.
The Nasdaq Composite ended December at 10,466.48, for a loss of 33 per cent over the 12-month period. That was the worst performance, by far, of any major North American index.
But this year it’s different. After a relatively slow start, the tech sector has been picking up steam and Nasdaq is now ahead 16.8 per cent for the first four months of 2023. We’re still a long way from the highs of November-December 2021 but there’s more optimism about tech stocks than we’ve seen in some time.
What happened? Here are some reasons for the turnaround.
Tech was oversold. Momentum is a major force in stock prices – both to the upside and the downside. During the pandemic years, all the momentum in the tech sector was up. The prices of some companies, like Teledoc Health, Roku, and DocuSign reached absurd levels. P/e ratios were off the charts. The “greater fool” theory drove investors to push prices ever higher.
It had to end and when it did it wasn’t pretty. Momentum turned around and the high-flyers experienced massive flame outs. The carnage was painful.
But it turned out to be a case of the pendulum swinging too far. Now it has turned in the other direction. For how long is hard to say but many tech stocks still look like reasonable values despite the recent run-up.
Cost-cutting. The days of playing fast and loose with cash flow are over. Tech companies have finally come to grips with the fact the bottom line matters. Staff are being laid off by the thousands. Research projects are being cancelled. Office space is being sold off or leases not renewed. New construction projects are being delayed, such as Amazon’s planned second headquarters near Washington.
Techcrunch.com reports that more than 158,000 people were laid off in the tech sector in the January-March period. In late April, Amazon announced it will close down its Halo Health division at the end of July. The job losses will bring the total at Amazon to 27,000 this year alone. It wasn’t that long ago the company was boasting about adding 100,000 new positions.
In its latest quarterly report, Alphabet wrote off $2.6 billion related to reductions in its workforce and office space. Microsoft and Meta Platforms are among the other tech firms that have written off billions relating to cost cuts.
Results are beating expectations. Last year was not a repeat of the dot-com bubble of 2000-2002. At that time, the internet was in its infancy, and, with a few exceptions, most tech companies were in the start-up stage or just out of it. Many were operating in the red, with their stocks offering investors great stories and exciting potential, but no profits. When people discovered the emperor had no clothes, the bottom fell out.
It’s a different story now. The technology industry is dominated by giant, money-making companies and the results they’ve produced so far this year have in many cases beaten expectations.
Artificial intelligence. Investors love an exciting story. This year it’s artificial intelligence (AI). Engineers have been working on it for years but the release of programs like ChatGPT to the general public has grabbed people’s attention and ignited a spirited debate about the future of AI and how to control it.
Companies that are leaders in this field have seen their share prices soar as investors scramble for positions in what appears to be the next generation of technological development. Shares in chip maker Nividia are up over 90 per cent year to date.
Microsoft, has incorporated AI into its Bing search engine in a move to increase market share. Last week, the company reported quarterly revenue of $52.86 billion (figures in US dollars), topping the consensus of $51.02 billion. Earnings per share were $2.45, which also beat the consensus of $2.24. The stock is up 27 per cent year-to-date.
Here are updates on two of my top Internet Wealth Builder tech picks.
Alphabet Inc. (GOOGL-Q)
Background: Alphabet is the umbrella company that owns Google (which includes Android, Chrome, and YouTube), Nest (home automation), Calico (anti-aging research), Fiber (high-speed Internet), Google Ventures (new company investments), Sidewalk Labs (city infrastructure), and Waymo (driverless cars). Other services include Google Maps, Google Play, and cloud computing.
Performance: After a slump in March, the shares rebounded strongly and are now trading near their year-to-date high.
Recent developments: The company’s first quarter results were flat to down from last year, but they came in well ahead of analysts’ estimates. Revenue was $69.8 billion, up 3 per cent from the same period a year ago (6 per cent in constant currency, figures in U.S. dollars). The expectation was for $68.9 billion. Google Search ad sales were up slightly, bucking an industry trend.
The company is working on several AI projects that it plans to incorporate into its search engines in the coming months.
Google Cloud revenue grew 28 per cent year-over-year to $7.45 billion.
Operating income was $191 million, the first time it has been in the black.
Net earnings were just over $15 billion ($1.17 per diluted share) compared to $16.4 billion ($1.23 per share) in the same period last year. The Street had expected EPS of $1.08.
Dividend and buybacks. The stock does not pay a dividend, but the company is actively repurchasing shares. In mid-April, the board of directors approved the repurchase of up to $70 billion worth of Class A and Class C shares.
Outlook: The days of double-digit growth are over, at least for now, but the company is holding its own in a highly competitive environment.
Background: Amazon is the largest on-line retailer in the world, but the company is also involved in many other businesses including cloud storage, video streaming, film production, voice-activated software (Alexa), and more.
Performance: The shares hit a 52-week low of $81.43 (U.S. dollars) in late December but have regained some ground since.
Recent developments: Amazon released first quarter results on Thursday. Revenue was up 9 per cent year-over-year to $127.4 billion, compared to $116.4 billion in the same period of 2022. This included a negative impact of $2.4 billion from foreign exchange rates. North American sales were up 11 per cent to $76.9 billion. Amazon Web Services (AWS) posted stronger-than-expected sales, which were up 16 per cent year-over-year.
Operating income increased to $4.8 billion in the first quarter, compared with $3.7 billion in 2022. This year’s operating income includes approximately $500 million in charges related to estimated severance costs.
Net income was $3.2 billion ($0.31 per diluted share), compared with a net loss of $3.8 billion (-$0.38 per share) last year. First quarter net income includes a pre-tax valuation loss of $500 million included in non-operating expense from the common stock investment in Rivian Automotive.
Free cash flow improved to an outflow of $3.3 billion for the trailing twelve months, compared with an outflow of $18.6 billion for the twelve months ended March 31, 2022.
Dividend: The stock does not pay a dividend.
Outlook: The company provided second quarter guidance. It expects revenue of $127-$133 billion (analysts estimate $129.9 billion) and operating income of $2.0 to $5.5 billion, which compares to the consensus of just over $4 billion. This compares with $3.3 billion in the second quarter of 2022.
Although both stocks appear to be in recovery mode, I would rate them a hold at this point due to concerns of a recession later this year.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe