Tech stocks were market leaders even before Covid-19, but the pandemic has really cemented these companies’ status. These reasons are obvious; these companies range from Alphabet (togetL) and Facebook (FB) to Amazon (AMZN), Apple (AAPL) and others have become more and more important for our life and work in these socially distant times.
Although these companies are not monopolies in the legal sense, they are still as sustainably profitable as if they were the standard oil of the past. The one point I want to make is that the leadership and dominance of these companies is not the result of a temporary development or a fad or even a bubble as some people claim, but rather a rational reflection of basic soil realities.
In other words, the notoriety of these tech companies in the stock markets reflects their enormous and growing profitability.
As we have emphasized at this point in the past, the composition of the stock market using the S&P 500 index as a proxy for the market has changed fundamentally in recent years. Again, this is a reflection of the changes in the broader US economy, with a rapidly growing and extremely dynamic technology sector infiltrating every corner of the economy.
The net effect of these compositional changes is that the technology sector is by far the largest contributor to the S&P 500 index’s performance, dwarfing the financial sector, which has had the largest earnings weighting in the index for many years. The following graph shows the earnings contributions of the Zacks Technology and Finance sectors since 2002, with the energy sector added to the mix to further highlight the aforementioned change in composition:
As you can see here, the tech sector (green line) is on track to generate 28.9% of the total S&P 500 index return in 2021, with 20% on finance and less than 2% on energy omitted.
In addition to making the most money, the tech sector has the best earnings growth profile, as shown in the following graph:
Please note that while tech earnings are on the way to declining -1.4% this year, earnings for the financial sector and the broader index are down -23.6% and -17.8, respectively for 2020 % is expected.
The growth prospects are even more impressive for the big tech companies, especially the Big 5 players: Apple, Microsoft (MSFT), alphabet, Amazon and Facebook.
The table below shows that the combined earnings of these 5 big companies are on track to grow + 13.1% with + 14% higher sales this year, followed by + 19.3% earnings growth and + 17.6% % Sales growth in 2021:
For a company, the size of Apple, growing its profits + 19% in 2021 and + 9% in 2022, is definitely impressive. Overall, the growth figures for Amazon are in a different world.
I’m not making a review comment here, I’m just discussing the result. Evaluation is like beauty – it is in the eye of the beholder.
There may be legitimate concerns that the valuation of some of these tech stocks may have gone a little too far, especially after the group’s impressive run-up this year. However, the valuation depends on both the interest rates and the prospects for profitability.
We can assume that in an environment where interest rates are likely to remain low for a long time, the market will be much more open to paying a higher multiple for these “high growth” companies.
Tech Sector Scorecard
For the tech sector, we now have Q3 results from 87.1% of the sector’s market cap in the S&P 500 index. The overall results of these tech companies rose 11.6% year-on-year to 8.6% higher sales, with 96.6% exceeding EPS estimates and 93.1% exceeding sales estimates.
The comparison tables below put these results in a historical context and in some ways show how the sector’s results in the third quarter are better compared to results in recent periods including the pre-Covid quarters.
The first set of comparison tables shows the third quarter earnings and sales growth rates:
The second set of comparison tables shows the third quarter EPS and sales exceeding percentages in the context of recent history:
Looking at the third quarter as a whole, the total earnings of the tech sector are expected to increase by + 10% compared to the same period last year, with + 7.7% higher sales.
Q3 Earnings Season Scorecard (as of Friday, November 6th)
We now have Q3 results from 447 S&P 500 members, or 89.4% of the index’s total membership. Total earnings (or total earnings) for these 447 companies were down 7.3% year over year, down 1.9%, with 85.2% beating EPS estimates and 76.3% beating revenue estimates.
The following two comparison tables put the Q3 results of these 447 index members in a historical context, which should give us an idea of how the Q3 earnings season is performing in this phase compared to other recent periods.
The first comparison tables compare the earnings and revenue growth rates for these 447 index members:
The second set of charts compares the proportion of these 447 index members outperforming EPS and revenue estimates:
As you can see above, not only is the pace of declines slowing, but a much larger chunk of businesses are exceeding EPS and revenue estimates.
The reporting cycle will slow noticeably in the future. This week, more than 500 companies reported third quarter results, including 15 S&P 500 members. Well-known companies reporting results in the coming week include Disney (DIS), Cisco (CSCO), Applied Materials (AMAT) and other.
When you look at the third quarter as a whole and combine actual results with estimates for companies to come, the index’s overall results are expected to decrease 8.9% versus 1.4% lower sales.
From a market perspective, the key factor is how the estimates for the fourth quarter of 2020 play out as we go through the rest of the third quarter reporting cycle. The trend so far has been positive, as the following graphic shows:
Please note that the revision trend has apparently flattened out over the past few days and estimates are actually stalling. The 11.7% decline for the fourth quarter was flat over the past week.
The following graph gives an overview of the quarters and shows the growth in profits (green bars) and sales (orange bars) in the third quarter in relation to what has actually been achieved in the last quarters and what is expected in the coming periods :
The following graphic shows the overall view on an annual basis. As you can see below, 2020 earnings and sales are projected to decrease 19% and 4.4%, respectively:
The above annual growth pattern roughly corresponds to an “EPS” index of USD 131.57 for 2020, compared to USD 160.04 in 2019 and USD 160.63 in 2021.
You can find a detailed overview of the overall results picture and the expectations for the coming quarters in our weekly report on earnings trends >>>> The picture of favorable earnings continues for the third quarter and beyond
Are you looking for stocks with a rapid upward trend?
Zacks just released a special report on the booming investment opportunities in legal marijuana.
With new referendums and laws coming, this industry is expected to explode from an already robust $ 6.7 billion to $ 20.2 billion in 2021. Early investors have to kill, but you have to be willing to trade and know exactly where to look.
Take a look at the Pot Trades We’re Targeting >>
Would you like the latest recommendations from Zacks Investment Research? Today you can download 7 Best Stocks for the next 30 days. Click here to get this free report