A Tale of Two Earnings Seasons
Financials and tech have turned in very different earnings so far, but there are still some values in both sectors.
Commentary
Second-quarter earnings have been a bit of a mixed bag so far. Some industries, like financial services, have been reporting consistently better-than-expected results, while tech companies are generally falling well-short. The divergence in fundamentals has led to a sizable difference in stock performance during the past week. Financials (as measured by Financial Select Sector SPDR (XLF)) are up 1.87% while the technology sector (as measured by Technology Select Sector SPDR (XLK)) is down 1.52% during the past five days. But these gyrations have not created much opportunity. In this fully valued market, investors need to stay focused on individual security selection and make sure they aren't overpaying.
The big banks all had quarterly results that easily exceeded analyst expectations. Morningstar's director of financial-services equity research Jim Sinegal observed that anything related to capital markets had a great quarter. Firms from Goldman Sachs (GS) to Morgan Stanley (MS) were able to report big trading gains as equity and other markets remained near high points. And with the increase in rates only affecting parts of the quarter, housing-related businesses at banks such as
Wells Fargo (WFC) still posted decent results. Sinegal also pointed out that one of the most remarkable feats in the quarter was how many of the institutions, notably Bank of America (BAC), were able to keep pushing expenses lower. During the five years since the crisis caused the financial industry to make deep cuts, management teams are still committed to finding new places to cut costs. All of these factors combined to paint a pretty cheery picture for Wall Street.
On the other hand, the large-cap tech results were much more downbeat. Firms are still struggling with the best way to transition to a device-driven world as PC sales took another tumble in the quarter. Microsoft (MSFT) was the poster child for these troubles. The software firm's shares fell more than 11% as the firm reported what Morningstar analyst Norman Young described as "abysmal" consumer demand for Windows. The firm also took a $900 million write-down on its Surface RT tablet inventory, confirming the tepid response to Microsoft's foray into the tablet world.
Intel's (INTC) results were in line with expectations, but management cut full-year forecasts as they, too, are under pressure from declining PC sales. The pain was not just limited to those with vested PC interests. Google (GOOG) also missed estimates as ad revenue and profitability came up short.
The big difference in results, and short-term performance, might lead contrarian investors to think that tech stocks are looking cheaper while banks stocks are looking pricey. In fact, financial-services stocks on the whole look more attractive than tech names today. The median tech stock we cover is now trading at a 9% premium to our analysts' estimate of its intrinsic value. That metric for the broader market is only 3%, and for financial-services firms it is 4%. Along with consumer cyclical stocks, tech is the most overvalued sector we follow today.
That doesn't mean there is nothing to invest in; you just have to pick your spots carefully. As I wrote last week, it can make sense to pay up for quality names when there are limited opportunities elsewhere in the marketplace. That means stick to companies that have strong competitive advantages (economic moats) that will allow them to keep generating cash flow for years to come and that aren't trading for unreasonable valuations.
To find these names in the tech and financial-services sector, we used the Morningstar Premium Stock Screener to find wide- and narrow-moat firms with Morningstar Ratings for stocks of 4 stars or higher. You can run the screen for
yourself here. Below are three names that passed.
Oracle (ORCL)
From the Premium Analyst Report:
Oracle is still at the top of the food chain in the software world. While there have been many critics of Oracle's long-date acquisition strategy, we believe the company has shored up its defenses, successfully anticipating the threat of cloud computing and providing its customers with a path for technology and service upgrades. Oracle's customers have high switching costs--particularly in the database and middleware markets--that provide extensive competitive advantages, support industry-leading profitability, and deliver excess returns on capital. While we cannot deny the potential disruptive force of cloud computing, we believe Oracle maintains the widest moat in our software universe.
Franklin Resources (BEN)
From the Premium Analyst Report:
With $815 billion in total assets under management, and one third of its managed assets sourced from clients residing outside the United States, Franklin is one of the larger global asset managers. The firm's wide economic moat has been built on the scale of its operations; the strength of its brands; and the diversity of its AUM by asset class, distribution channel, and geographic reach. While Franklin traditionally has been more equity-heavy, the dramatic shift in investor risk appetite over the last several years has left it with a more balanced portfolio. Franklin has also been one of the better organic growth stories in our coverage universe, generating a significant amount of inflows through its fixed-income division since the start of calendar 2009.
F5 Networks (FFIV)
From the Premium Analyst Report:
During the last five years, F5 Networks' differentiated approach to network traffic management has allowed it to steadily gain share from much larger rival Cisco Systems in the rapidly growing application delivery controller, or ADC, market. We think F5's technological lead and the proven value of its products to customers positions the company for ongoing success for years to come, despite increasing competition over time.
All data as of July 19.