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By Jeremy Glaser and Matthew Coffina, CFA | 09-26-2013 11:30 AM

Third-Quarter Earnings: Sectors to Watch

StockInvestor editor Matt Coffina tracks the trends and valuations in the durable goods, discretionary, and tech sectors, as well as the impact of higher rates.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We're on the verge of third-quarter earnings season, and I'm talking today with Matt Coffina, the editor of Morningstar StockInvestor, to look at some big themes that he will be watching throughout the earnings season.

Matt, thanks for joining me today.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: You mentioned that companies that deal with durable goods are posting better results over the last few quarters than those that have more discretionary products. Is that something you expect to continue in the third quarter?

Coffina: That's a trend we've seen over the last few quarters. Companies that sell automobiles, appliances, and larger items like that have been doing better than companies that sell more discretionary items. For example, we're seeing companies like Lowe's or CarMax which are two holdings in StockInvestor's Hare portfolio outperform companies like Wal-Mart, which we also own. I think that this is probably, more than anything, a result of pent-up demand from the recession. People held out on a lot of those big-ticket items during the recession, and now especially with low-interest-rate environment, those items are only getting older over time. They need to be replaced eventually, and so that pent-up demand is working its way through the system.

I think that that is likely to be continued in the third quarter, but it's not a trend that will persist forever. At some point, the pent-up demand is going to be worked off, and assuming the economic recovery continues, we would hope to see more discretionary items also start to pick up steam over time.

Glaser: Another area that's been doing well other than durable goods has been Internet advertising. There are high hopes for this quarter, we've seen some big runups in stocks like Facebook in expectation of that. Do you think these hopes are justified? Do you expect to see some pretty big numbers from the Googles and Facebooks of the world?

Coffina: We saw a huge shift in sentiment in the last quarter with companies like Google and Facebook. Investors were down on them earlier in the year, worried that [the firms] weren't going to be able to navigate the transition of mobile computing to tablets and smartphones and effectively monetize their advertising on those platforms. Especially after Facebook reported just a blowout second quarter, investors have come around to the idea that mobile advertising will be just as profitable as desktop advertising over the long run.

I think that these companies are also positioned to do fairly well in the third quarter fundamentally. What I'm less certain about is what the stock valuations are already implying. I think hopes are running pretty high in a lot of these names.

Facebook, especially, is trading at a pretty steep premium to our fair value estimate, and so that does make me nervous that if the growth doesn't accelerate in the way investors are hoping for, then the valuations are baking a little too much optimism in at this point.

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