Tech stocks have been the best performers in the market this year. This momentum has been fueled by a combination of favorable developments on the macro front, primarily increasing clarity around the Fed tightening cycle, optimism about the impact of artificial intelligence (AI) that some warily view as throwbacks to the late 1990s, and an emerging sense that the worst of the headwinds in tech spending are either behind us or close to it.
With many tech companies on deck to release their June quarter results this week, the market will be looking for more color on enterprise spending trends, especially on the cloud side. Much of Tech’s improved earnings outlook in recent months has been due to more effective cost controls that have helped stabilize margins.
Greater clarity on revenue trends will help consolidate the emerging trend of favorable revisions and support the group’s impressive stock market momentum.
Surrounding all of this is the AI debate, where we have already seen the direct revenue impact of Nvidia NVDA and some ideas from Microsoft MSFT. Yet the productivity-enhancing potential of innovation seems to be a long way off in the future.
That said, the stock market is essentially a system for discounting the future. As we see viable business models in the days ahead that use AI, so-called big language models beyond Nvidia selling higher performance chips, and Microsoft starting to charge for new AI-based bells and whistles in its Office productivity suite, the stock market excitement would be totally justified.
These topics will be the focus of this week’s earnings reports from three of the “Big 7 Tech players.” Alphabet GOOGL and Microsoft MSFT report after the market close on Tuesday (7/25), and Instagram parent Meta Platforms META reports after the close on Wednesday (7/26). Of the four remaining members of this “club”, Tesla has already reported, and Amazon, Apple and Nvidia are not reporting this week.
The chart below shows the year-to-date stock market performance of Zacks Technology (third from bottom; up +38.7%), the S&P 500 Index (bottom row; up +18.9%), Alphabet (second from bottom; up +36.3%), Microsoft (second from top; up +44.6%) and Meta (top row; up +147.2%). %).
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Digital advertising has always been considered central to Alphabet and Meta, but Amazon has also become a major player in the space. Ad spend likely held steady in the second quarter, but it will be interesting to see how these management teams view trends for the current and future periods, given the macroeconomic uncertainties. That will also be in play in the Snap SNAP report, which also reports Q2 earnings on Tuesday (7/25) this week.
All of these companies are big players in the field of artificial intelligence (AI), with Microsoft’s rivalry against Alphabet being particularly intense. With the initial enthusiasm for ChatGPT and other AI applications now behind us, the questions now turn to how these AI capabilities will be monetized through new and existing business models. It’s reasonable to expect each of these leadership teams to spend significant time on their Q2 earnings calls on their AI plan.
Take a look at the chart below which shows the current consensus expectations for the “Big 7 Tech Players” as a whole for the current and future periods in the context of what they achieved in the previous period.
As you can see, the group should have +14.7% more profits in Q2 2023 on revenues up +8%. This would follow earnings down -2.5% on revenues up +4.9% in Q1 2023.
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Please note that the +14.7% earnings growth and +8% revenue growth in Q2 today is up from the +4% earnings growth and +4.3% revenue growth expected for the group three months ago. As with the second quarter, estimates for the full year 2023 have also increased significantly.
The graph below shows the group’s profit and revenue growth on an annual basis.
Image source: Zacks Investment Research
The group’s phenomenal surge in 2021 partly reflects the pulled-forward demand from future periods that was adjusting last year and this year. As you can see above, the group is expected to return to “steady/normal” growth next year, but much depends on how the macroeconomic situation develops.
Looking beyond these mega-cap players, total second-quarter earnings for the tech sector as a whole are expected to be down -4.4% from the same period last year, with revenue down -0.1%.
The chart below shows the industry’s Q2 earnings and revenue growth forecast in the context of growth over the past few quarters and what is expected for the next four periods.
Image source: Zacks Investment Research
This overview of the “Big 7 players” and the sector as a whole shows that the worst growth challenge is moving into the rear view mirror. You can clearly see this in the table below.
Image source: Zacks Investment Research
Please note that the -1.9% decline in earnings expected for the sector is less than half of the -4.8% decline expected three months ago.
The overview of benefits
Regular readers of our earnings commentaries will know that we have consistently reported a favorable turn in the revisions trend since the start of the second quarter of 2023, with earnings estimates stabilizing overall after falling steadily for nearly a year and starting to rise for some key sectors.
This combination of favorable macroeconomic developments and optimism about the transformative power of artificial intelligence (AI) appears to be driving market optimism.
To get an idea of what is currently expected, take a look at the chart below which shows the current earnings and revenue growth forecasts for the S&P 500 Index for the second quarter of 2023, the following three quarters and the actual results for the previous four quarters.
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As you can see from this chart, the second quarter is on track to be the third consecutive quarter of declining earnings and the first quarter of declining revenue. It should be emphasized here that much of the weakness in profits and revenues is due to the energy sector. Excluding the slowdown in the energy sector, Q2 earnings would be down -2.9% on revenues up +3.1%.
The chart below shows the year-over-year change in net profit margins for the S&P 500 Index.
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As you can see above, 2023 Q2 will be the 6e consecutive quarter of declining margins for the S&P 500 index.
Second-quarter margins are expected to be below year-ago levels for 12 of Zacks’ 16 sectors, with the greatest pressure on margins expected to be in the basic materials, construction, energy, medical, conglomerate, automotive, aerospace and technology sectors.
On the positive side, the financials sector is the only one expected to experience significant margin gains, with the consumer discretionary and transportation sectors ranking a distant second and third. The sectors that are expected to be essentially flat in terms of margins compared to the second quarter of 2022 are retail, utilities and industrials.
The chart below shows profit and revenue growth on an annual basis.
Image source: Zacks Investment Research
As mentioned earlier, the trend in estimate revisions has notably stabilized since the start of Q2. All told, S&P 500 earnings estimates for 2023 are down -1.2% since early April, but only -0.3% excluding energy. It is important to note that estimates for sectors such as technology, construction, automotive and transportation have increased over this period.
Dashboard of 2nd quarter results
We are entering the heart of the second quarter earnings season, with more than 650 companies on deck to report their results, including 165 members of the S&P 500 or a third of the total number of index members. With the results of 89 index members already published until Friday July 21stwe will be halfway through the second quarter reporting cycle by the end of this week.
Total second-quarter earnings for the 89 members of the S&P 500 were up +3.4% from the same period last year on revenue up +8.5%, with 78.7% beating EPS estimates and 60.7% beating earnings estimates.
The comparison tables put the Q2 results of these 89 index members with what we had seen from the same group of companies in other recent periods.
Image source: Zacks Investment Research
The comparison charts below put Q2 earnings and revenue growth rates for these 89 index members in historical context.
Image source: Zacks Investment Research
For a detailed look at the overall earnings picture, including expectations for the periods ahead, please see our weekly Earnings Trends Report >>>> Second Quarter Earnings Season is off to a positive start
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