Earning season is in full swing and over the course of the past week and end of the previous, many of the big tech companies have presented their quarterly figures to markets. There’s a couple of the big boys still to go, notably Apple on November 1st and Facebook next Tuesday, October 30th.
It’s been a mixed bag so far with strong results boosting tech giants such as Netflix, Microsoft, Tesla and Twitter. However, Amazon and Alphabet, Google’s parent company, missed forecasts. It’s been something of a reversal on how earnings season played out three months ago with the theme being those who missed forecasts at the end of July have beaten them this time around and those who beat expectations over the previous quarter failing to live up to that again.
Despite the fact that there have been several high profile tech companies to post results over the last several days that were better than expected, the twin disappointments of Alphabet’s and Amazon’s results have hit markets hard. The FTSE 100 today dropped to a 22-month low and U.S. equities have seen the remainder of 2018 gains wiped out over the past couple of days. Unless there is a major and unexpected turnaround over the first half of next week, it looks like October will end up as the worst month suffered by the tech sector since 2008.
But why have markets reacted so strongly to poor results from a minority of big tech companies? Let’s first round up big tech’s earnings season so far and then examine that question in more detail.
Tech Results Round-Up
Content streaming company Netflix, which was a major disappointment last time around posted a particularly strong set of results last week. Revenues of $4 billion matched forecasts but earnings per share on that were 89 cents when 68 cents had been expected. New subscriptions totalled close to 7 million against analyst predictions for 5.3 million. There was strong growth in overseas markets and the domestic U.S. market also returned to a positive trajectory with 1.1 million new paying accounts added over the quarter.
Guidance for Q4 was also more bullish than anticipated, at 9.4 million against the forecast 8.35 million. Netflix’s share price surged almost 16% after its quarterly posting, though those gains have since been wiped out by the wider tech sell-off since.
Twitter was another tech stock whose recent earnings reports have disappointed but returned to form with a bang. Despite a drop in overall user numbers, news taken positively by investors as simply a necessary side effect of the company’s efforts to clean up fake spam accounts, Twitter’s share price leapt 18% as it reported higher revenues and profits than had been predicted by analysts.
The purge of millions of spam and bot accounts, as well as those of aggressive ‘trolls’, appears to be having the desired effect on the overall ‘health’ of the micro blogging platform from the point of view of real users and advertisers. Revenue for the quarter came in at $758 million against forecasts of $700 million. The company has proven that user numbers can fall and advertising revenues, which reached $650 million, rise. That was a 29% improvement on the same quarter the previous year and boosted by a successful nudging of advertisers towards video and live event options. The quarter has demonstrated that quality not quantity of Twitter users is what will drive the company forward sustainably.
Overall, Twitter has come out of this earnings report in a stronger position than when it entered it even if that appears to have unfortunately coincided with a tech sell-off meaning the strong share price rise that resulted was short lived.
Tesla has certainly generated plenty of publicity over recent months, far from all of it positive and much of the negative the result of ill-judged comments and actions of CEO Elon Musk. Musk was recently fined £15.5 million by the SEC, and forced to give up his position as chairman of the company’s board and a handful of other concession, for posts made on Twitter that he had secured funding to take the company private. The threat had been made in response to Tesla becoming the target of short sellers as the most shorted company in history and what Musk believes is the short-sightedness of Wall Street and focus on quarterly results inhibiting how longer term goals must be approached.
The fine was for ‘misleading investors’, with the SEC coming to the conclusion that the claim that Musk had funds in place to take the company private at $420 a share had no basis. In fact, as Musk himself later admitted, the $420 figure was plucked out of the air because the term 4/20 is slang within cannabis smoking culture.
However, despite all of the arguably unnecessary distractions over the past few months, Tesla and Musk came through with their quarterly results this time around. Contrary to analyst expectations, Tesla managed to record its first quarterly profit in two years. Musk had made confident statements that sales of the Model 3 would drive Tesla into profit before the end of the year but analysts had forecast losses of 19 cents a share on revenue of $6.3 billion. In the end, revenues of $6.8 billion resulted in a net income of $312 million and profit of $1.75 a share. Revenues represented 129% growth on the same period last year, which had seen losses of $3.70 a share.
Tesla’s propensity for burning through cash has also concerned Wall Street but the flow was stemmed with positive free cash flow of $880 million over the three-month period. Gross profit margins on sales of the Model 3 also came in at just over 20% with the aim of achieving 15% given as forward guidance for the last three months of the year.
Microsoft’s quarterly report was also a success story. A more mature business than most of the other tech companies, which are high growth and at a much earlier point in their business lifecycle, Microsoft is not one of the FAANGs despite being the third most valuable company in the world after Apple and Amazon. Microsoft has again leapfrogged Google-parent Alphabet’s market capitalisation as a result of its strong showing over the 3 months its most recent set of figures covers.
Over recent years, Microsoft’s growth has been driven by its cloud computing business. Its most recent set of results suggest the pace of that growth is now slowing. That might have been considered a negative for the software company if it hadn’t been for the fact that it still managed to grow profits over the period by a third. £6.8 billion was added to Microsoft’s coffers over the quarter. Revenue was also up 19% at £22.68 billion.
Over recent years Microsoft has switched its focus away from the Windows operating system, which the company was built upon. The Office software suite and its new subscription model is leading growth alongside the Azure cloud service. Despite slowing, the latter still recorded growth of 76% compared to the same period of last year. Ordinarily, that would count as a phenomenal growth rate but is a drop within the context of 89% growth over the previous quarter. Other units also performed strongly, including LinkedIn the professional social networking platform that grew revenues by 33%, the company’s Xbox gaming division and Surface laptops unit. Overall, a strong quarter for Microsoft.
Alphabet may have been, along with Amazon, one of only two of the tech giants to fall short of analyst forecasts for their quarterly report. However, as the fourth largest company in the world, and third biggest FAANG after Apple and Amazon, markets have reacted particularly badly to the disappointment provided by Google’s parent company.
For eight quarters in a row, leading up to last week’s results, Alphabet had beaten estimates. The problem with routinely surpassing analyst forecasts is that sooner or later, when a company does falter even slightly, there is a market reaction that is usually an exaggeration on that which might be expected for another company that hasn’t set the bar quite so high.
Last Thursday Alphabet did finally miss a step as it fell slightly short of analyst expectations for revenue of $34.04 billion (£26.56 billion). The actual figure was $33.7 billion (£26.29 billion). Net income came in at $9.19 billion (£7.17 billion). Despite that representing an improvement of 21% on the same period last year and earnings per share of $13.06 (£10.19) a huge 25%+ ahead of forecasts for $10.42 (£8.13), Alphabet’s share price initially plunged by 5% before steadying.
On the one hand there is a strong argument that the disappointment shown by markets was not commensurate to the crime. The quarter’s results had plenty of positives. On the other, it demonstrates the current fragility of sentiment against the backdrop of the high valuations giant tech commands. If growth shows any evidence of easing off, faith in the huge bets placed in current valuations will be easy to shatter.
Amazon’s results the same day demonstrated that precarious reality even more acutely. The share price of the online retailer, content streamer and cloud services provider dropped 9%, representing a market value fall of $80 billion (£62.42), after sales targets were missed. It was Amazon’s biggest drop in over four years.
At the heart of the disappointment were slowing growth in Amazon’s international ecommerce business as well as its forecasts for sales over the fourth quarter which includes the holiday seasons of Thanksgiving, Christmas and the run-up to New Year. Amazon forecast sales of $72.5 billion (£56.57 billion) when analyst estimates had expected the figure to be $73.9 billion (£57.66 billion). Growth for the international sales division, which accounts for 27.5% of all sales, was less than half of the previous quarter at 13.4%.
Most analysts agree that the company’s long term growth prospects look very solid, and the fact that growth is spread across different business verticals from ecommerce to cloud computing and content streaming is also attractive.
Facebook and Apple have still to report and will do so this week on Tuesday and Thursday respectively. Apple are expected to report a strong quarter, again boosted by the attractive margins on new £1000 iPhone handsets offsetting stagnant growth in unit numbers sold. Some analysts believe that particularly strong results could catapult Apple to a valuation of $1.5 trillion, just a few short months after it became the first company to hit a trillion-dollar valuation.
Facebook’s results are expected to be more ‘mixed’, which could see its share price, which has already fallen over 30% since August, meet the same fate as those of Amazon and Alphabet. Sales are expected to improve by a third on last year to $13.8 billion (£10.77 billion) but profits to see a 10% slide as a result in investment in technology and staff to combat problematic content such as the ‘fake news’ that has recently become a fixture of public awareness.
Why Did ‘Mixed’ Amazon and Alphabet Results Lead to a Major Sell-Off and What Happens Next?
There are a number of factors behind why markets reacted so negatively to results posted by Amazon and Alphabet that would, under normal circumstances, be considered little worse than slightly underwhelming. Why did the whole tech sector see a sell-off, when the majority of companies posted forecast-busting results?
The first, and perhaps biggest, reason has already been mentioned. Markets have entered a period of fragile confidence. A multi-year bull run now considered the longest in U.S. equities history has seen valuations soar with those of the high growth tech companies especially aggressive. Many investors are beginning to anticipate the end of the cycle. While they don’t want to miss out on gains by cashing out too quickly, they are clearly worried about being burnt by holding onto positions for too long. This is evidenced by the fact that last week was the third significant correction U.S. equities have suffered this year with each deeper than the last. Investors are jittery and are hedging their bets by selling down when market confidence is tested.
Second is the related fact that with so much international capital tied up in the giant U.S.-listed tech companies, which have grown in value so much over the last few years, there has been a level of pre-emptive profit taking with investors locking in returns by selling stock.
Third is the suspicion that the multi-year equities bull run that has been in place since the end of the 2008 financial crisis is already actually largely over. In most of Asia and Europe major indices are down or flat for the year to date. Wall Street has continued to forge ahead but at least a significant part of that can be put down to the slashing of corporation tax earlier this year. The fear is when that ‘artificial’ boost runs out, coinciding with the fact that the era of ‘easy money’ from quantitative easing is being brought to an end around the world, Wall Street and big tech will face the realities of the world’s other major developed and emerging stock markets.
There is no guarantee that markets won’t regain confidence if Q4 results remain strong and forecasts for 2019 are optimistic. It may not be the end of the bull cycle for the wider stock market and technical stocks in particular.
But the growing anticipation that it may well be is what is leading to volatility that might initially look like an overreaction to Amazon and Alphabet’s ‘mixed’ quarterly results. Further signs will be looked for that growth is generally slowing and with confidence fragile it would be expected to require another sustained period of positive news from the biggest tech companies to put market sentiment back on solid foundations. The more likely scenario is that a period of volatility lies ahead and investors should mentally prepare themselves for a rougher ride.