The early part of each quarterly earnings season is focused on technology and communication companies. Thus far, the street has reacted well to news from technology companies and poorly to results from communications companies. This is a perfect example of the expectations game that is so prevalent on Wall Street. Understanding what has happened so far might help as many media companies are due to report in the next two weeks.
Heading into this earnings period, technology stocks sold off sharply on concerns about demand given weaker economic data around the globe. Many technology companies, especially those exposed to enterprise computing, had warned about weakening revenue trends. Foreign exchange was also a big worry. Technology companies are global as the language and use of technology crosses borders with ease. Furthermore, mega trends toward mobile broadband, smartphones, and big data are global. Many technology stocks had corrected 20%-30% from their highs in early spring. The combination of already decimated stocks, lowered estimates, and bearish investor sentiment set the expectations bar very low. Consequently, results and guidance that was merely in line with expectations, or even just better than feared, was greeted by sizable relief rallies in the stocks. Let’s take a look at a few high profile examples in technology.
(QCOM), and EMC Corporation
(EMC) each reported results that were very close to lowered expectations. Guidance commentary was similarly as expected, but Qualcomm actually guided lower although not as badly as feared. Google does not provide guidance, but comments on business trends indicate no deceleration beyond the impact of foreign exchange. EMC reaffirmed its guidance, confirming the power of data storage trends. Wall Street was prepared for much worse. To reiterate, in the short-term, stocks react to news based on expectations. Expectations were low for Google, Qualcomm, and EMC due to macroeconomic fears. As it turned out, good operating execution and powerful long-term business trends allowed each company to beat the lowered expectations. In turn, the stocks rallied sharply.
The story in communications was almost the exact opposite. AT&T
(T) and Verizon
(VZ) are early reporters each earnings cycle. Both stocks had rallied sharply since reporting March quarter earnings. There was good reason to rally. Both companies are seeing better profitability trends in wireless as margins expand with tougher upgrade policies. The payoff from sales of high priced smartphone data plans was finally coming through. The stocks also benefitted as investors sought out defensive investments against the backdrop of slowing global economic growth and the rising risk that the euro implodes. Hefty dividend yields and predictable (albeit low) growth businesses made the telco giants perfect stocks in a storm.
AT&T and Verizon each reported June quarter results in line with estimates and reiterated full year guidance targets. Verizon saw a little weakness in its wireline businesses, but the core story for both companies revolves around wireless and a mix shift away from declining legacy businesses. No problems at all on that front. So how did the stocks react? Verizon has dropped 6.5% since reporting last week, including 2% today following AT&T’s report. AT&T was down 3% yesterday despite a clean report and what I thought was a good conference call. This is a perfect example of the expectations bar being set too high. Rising stock prices and earnings estimates and improving investor sentiment left the stocks in a position where the earnings and guidance had to be better than expected even if the long-term story is unchanged.
Many more media and communications companies are set to report in the next three weeks. It is important to be aware of this set-up in the expectations game as the reports roll in. I wish I could predict if buying the out-of-favor stocks ahead of the reports remains the way to go. I think that will be the case. However, just one high profile reaction in the other direction could shift the dynamic. As is often the case during earnings season, I am trading less and sticking with my long-term favorites. Volatility is part of the market these days. I can explain the moves but anticipating the short-term is almost impossible. Keeping focused on whether my long-term investment thesis is intact remains my best bet for making money for my clients.
This column was previously published by SNL Kagan on www.snl.com.
No positions in stocks mentioned.
Entermedia is a long/short equity hedge fund focused on media, communic=
ations, and related technologies. Steve Birenberg is co-portfolio manager o=
f Entermedia, owns a stake in the Funds' investment management compan=
y, and has personal monies invested in the Funds. CBS and Discovery Communi=
cations are widely held by Northlake Capital Management, LLC, including in =
Steve Birenberg's personal accounts. Steve is sole proprietor of Nort=
hlake, a long only registered investment advisor.
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