Tech Sector Earnings Are Coming Up: What's Been Going On In Q4?

The tech sector was the best performer in 2017 and has started 2018 off on a strong note. After breaking through the 7000 level for the first time ever at the beginning of the new year, the tech-heavy Nasdaq (COMP) has climbed higher and is up 2.92% as of January 11.

 It remains to be seen if the rally can continue over the next few weeks as earnings season gets underway. Out of the S&P 500’s (SPX) 11 sectors, the tech sector is expected to report the third highest year-over-year earnings growth with analyst estimates coming in at 15.9%, according to FactSet. Five out of the seven industries in the sector are expected to report year-over-year earnings growth, led by semiconductors and semiconductor equipment (37%), internet software and services (33%) and IT services (12%).   

On the top line, analysts have indicated they are expecting double-digit revenue growth of 15.9% year over year, also according to FactSet. The internet and software services industry is expected to lead the way with an estimated 23% year-over-year growth rate.

In 2017, artificial intelligence, cloud computing, the internet of things,  autonomous cars, and blockchain were some of the bigger trends in technology. The sector is known for its rapid pace of change, which only seems to accelerate. Just look at all the new products companies had on display at CES, the annual trade show organized by the Consumer Technology Association, or CTA, that just wrapped up.

Ahead of CES, the CTA released its semi-annual industry report covering U.S. consumer technology sales and forecasts. For 2018, they are expecting consumer technology retail revenues to grow to $351 billion, up 3.9% compared to last year.   

TECH IN Q4. The chart above shows the S&P Technology Select Sector Index’s (IXT) performance from October 1 through December 31, with notes of some of the events that happened during the fourth quarter. Earlier on in the quarter, the sector rallied as tech earnings, for the most part, beat analyst estimates. Chart source: thinkorswim^® by TD Ameritrade.  Data source: Standard & Poor’s. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

Cybersecurity and New Vulnerabilities

Tech news has been dominated lately by Google Project Zero’s discovery of security vulnerabilities in CPUs, known as “Meltdown” and “Spectre”, that have the potential to affect just about every modern computer. The vulnerabilities were discovered last year, and many companies across the tech industry have collaborated to come up with solutions to protect users.

In the days after the news broke, chipmakers Intel Corporation INTC and Advanced Micro Devices, Inc. AMD were more volatile as more details emerged about how the two companies’ products were impacted. As a result of the widespread use of these chips, major tech companies including Alibaba Group Holding Ltd. BABA, Amazon.com, Inc. AMZN, Alphabet Inc GOOG GOOGL and Microsoft Corporation MSFT, among others, have issued statements about steps they’ve taken to fix the vulnerabilities.

Holiday Sales for Tech Products

Per usual, many companies launched new products before the holiday season, the busiest time for retail. Apple Inc. AAPL, Amazon, Alphabet and Microsoft are just some of them that rolled out new products.

Upcoming fourth-quarter results could possibly shed some additional light on how some of these items performed over the past few months. These results might be even more critical for companies that generate a bulk of their revenue from a limited number of products. 

On a broader level, U.S. retail sales were strong in the fourth quarter. The Commerce Department just released advanced estimates for December this morning, which showed a 5.5% increase in Q4 compared to the prior-year quarter, outpacing the 4.2% increase for all of 2017.  Many overseas economies in Asia, including China and Japan, also reported stronger retail sales in recent months. However, there have been mixed results across different parts of Europe.  

Impact of Tax Reform

In recent quarters, the prospect of tax reform has come up time and again on earnings calls for the big tech companies. Now that the bill has actually passed, it’ll likely be a topic that comes up again.

Over the years, many of the biggest tech companies have earned tens of billions of dollars in overseas profits, only they haven’t brought them back to the U.S. to avoid having to pay significant taxes on them—something that many tech executives have been vocal about.

Part of the tax bill included a one-time tax break on repatriated cash, cutting the tax rate to 15.5%, quite a bit lower than the prior top rate of 35%. Several companies have previously indicated they’d largely use tax savings for paying down debt, stock buybacks and dividends, and mergers and acquisitions.

Outside of the repatriation tax break, the tech sector isn’t expected to benefit as much from the reduced corporate income tax rate, which was cut to 21%, since its overall effective tax rate is 18.5%, according to Bloomberg.

Looking Ahead to Earnings

At the end of January and the start of February, a bulk of the biggest tech companies in the world will be reporting Q4 results. Both MSFT and Facebook, Inc. FB report after market close on Wednesday, January 31. The following morning on February 1, Alibaba (BABA) reports and AAPL and GOOGL are scheduled after close that day. Also, Amazon is expected to report around the same time frame.

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