Earnings Season Is Here. It Won’t Be Easy for Tech Stocks.

Earnings for the likes of Netflix,
Apple
(AAPL), and
Alphabet
(GOOGL) might not spur big gains, though. That’s partly because those stocks have already staged impressive rallies, and the medium-term earnings outlook for the sector contains some obstacles, too.

The Nasdaq-100 Index—comprised of the 100 largest nonfinancial companies by market value on the Nasdaq stock exchange—has jumped about 19% this year, more than double the
S&P 500
‘s gain.

The main driver for tech’s gains has been a dip in long-dated bond yields, which have fallen in tandem with the expectation that the Federal Reserve could soon pause its interest-rate increases, possibly within the next few months. Lower long-dated bond yields make future profits less valuable, and many large tech firms are still valued on the basis that a bulk of their fast-growing earnings will come many years in the future. 

Now, these stocks are trading at fairly expensive valuations. The aggregate forward price-to-earnings multiple on the Nasdaq-100 is almost 25 times, up from just under 21 times to start the year, according to FactSet. Apple trades at just under 25 times from about 20 times at the start of the year, and Amazon.com (AMZN) trades at about 58 times, from around 46 times at the start of 2023. 

That puts an even greater burden on these companies to produce earnings that can justify such elevated valuations. The results must beat estimates by a particularly wide margin if they want the market to assume a large enough forward earnings stream to support current share prices. Or the earnings could beat estimates more narrowly, but then management teams’ outlooks would need to be better than tepid.

Overall, it seems unlikely that strong guidance or earnings would be enough to shift the full-year profit outlook upward.

“While the NASDAQ-100 is trading as if it will shield investors from a downturn, fundamentals look very vulnerable to us,” wrote Chris Senyek, chief investment strategist at Wolfe Research. 

To be sure, 2023 per-share earnings expectations are already down. The aggregate analyst EPS estimate for the current calendar year for the S&P 500 tech sector (which is comprised similarly to the Nasdaq-100) has dropped about 16% from its peak in the middle of last year, according to Wolfe Research.

“Tech spending looks poised to meaningfully disappoint, online advertising and shopping are very unlikely to escape a broad slowdown, and we expect weak earnings trends to continue into 1Q earnings season,” Senyek wrote. 

Tech spending would be unlikely to fully rebound in 2024, further strengthening the pessimism on tech stocks—even if these companies’ first-quarter earnings reports are more robust than expected.

While some tech companies are still growing sales quickly, a slowing economy could interrupt some of that. For instance, weakening consumer spending could lead to slower growth for Amazon’s e-commerce business, even though digital retail is still growing and taking share from bricks-and-mortar in many countries. And if consumer brands see a hit to sales, they’ll likely cut back on their advertising budgets, hurting Amazon’s ad business. 

To that point, the 2024 aggregate per-share earnings estimate for the tech sector is only down 7% from its most recent peak—suggesting that analyst estimates remain too high. This forecast reflects the expectation for a quick economic recovery from this year, as the Fed eventually stops hiking interest rates and economic activity stabilizes. That might prove optimistic: A stabilization of higher rates—as opposed to rate cuts—might not be enough to drive a full recovery in profits. In turn, companies could actually warn about forward-looking results. 

The easy money in tech stocks has likely already been made in the first few months of this year. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com