Friday Five: Banks Start Earnings Season Without a Bang

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five, Morningstar's take on five stories in the market this week.

Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: First this week: Bank earnings kicked off earnings season, and I guess you could say they went off without a bang?

Glaser: It was not a terribly exciting quarter for the banks, and that's not necessarily a bad thing. Given the amount of drama that surrounded these big institutions for so long, having a quarter that was more or less normal is a good sign.

There are a few key trends, one being what was happening with trading revenues in a quarter that was very volatile. Goldman Sachs, in particular, really benefitted from that volatility in their earnings.

There were some signs, particularly at Bank of America, that some of the legal and regulatory woes might be receding somewhat. But as we saw from JPMorgan and others, they are not completely out of the woods yet, and heightened regulatory scrutiny is something that banks are going to be living with for a long time.

And then at the core of their business, this very low interest rate environment is making it very difficult to expand net interest margins and profitability. Banks are going to need a more normalized interest rate environment to really see their profitability rise.

And finally is cost-cutting: All the banks seemed to be successful in finding areas that they can cut costs in order to continue to drive earnings, even in this low interest rate environment.

Stipp: Big pharma firm Johnson & Johnson also reported. They had a steady quarter, but not perhaps without any bumps at all.

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Glaser: Our analyst Damien Conover described it as steady. It was driven by the drug business; pharmaceuticals are really driving Johnson & Johnson's performance. The consumer group did OK, and the device business continued to struggle. Damien thinks these basic trends are going to continue in the years to come, but drugs are going to slow down. Some generic competition is coming online in a few years, and J&J's late-stage pipeline is not incredibly strong; there aren't a lot of drugs waiting in the wings to take over some of that revenue. You are going to see growth slow there.

Some of that slack will be picked up by the consumer business, which has had some issues with manufacturing and some other issues, but those strong brands, we think, will continue to resonate with consumers, and the firm will see some growth there.

The device business, on the other hand, looks likely to continue to have some weakness and will be the weak link there for some time.

Stipp: Over in the tech sector, Intel reported results, and you might say this firm is doing the best it can in a tough environment.

Glaser: Intel had provided some guidance that this was not going to be a great quarter, and that played out in the sense that they had a flat revenue year-over-year, and it was down 13% from the fourth quarter. That really represents the weak PC environment we are in. People just aren't buying PCs. There are some inventory issues--the chips are not exactly flying off the shelves.

But the stock actually popped on the results, and I think there are a couple of reasons for that. First is that Intel did provide the guidance that it was going to be a relatively weak quarter. So it didn't come as a big surprise. The server business is still growing. Cloud computing growth is benefiting Intel, and that really showed in that part of the business.

Partially it's also that they cut their capital spending budget from $10 billion to $8.7 billion in order to make sure that capacity meets demand. Intel is not going to do a bunch of capital spending to create capacity for chips that nobody wants to buy. That kind of discipline is something that investors are looking for--a management team that is going to make sure they are spending their money wisely. The market cheered that as well.

Intel shares don't look particularly cheap right now, but certainly it's nice to see that kind of prudence.

Stipp: Netflix shares soared after the firm reported adding more customers than expected, but this firm's success is no secret to the market.

Glaser: Netflix had another strong quarter, and it was driven by that subscriber growth number, which is the metric that a lot of people are focused on. They added more people than expected. They now have 59.6 million users versus only 46.1 a year ago. They are still growing at a very nice clip.

A lot of that growth is coming from excitement for their original programming. Many people, including us, were somewhat skeptical of Netflix's ability to take original programming, promote it, and get people excited about it over the long term. It really seems like they have cracked the code of how to do this, and consumers are responding to it. Neil Macker, our Netflix analyst, believes they are going to be able to continue to do this profitably over time, and this will be a big driver of Netflix. You add in views from some of the content deals that they've signed with other parties, and you end up with a nice value proposition.

But like you mentioned, this is not exactly a giant secret. Netflix's growth has been well-documented, and a lot of very substantial growth from here is already baked into the share price. So even if we see good results from Netflix in the future, if you're paying too much for it, it's not something that you're going to be able to experience. Right now we think you are better off just watching Netflix versus owning the shares.

Stipp: We got news this week that the EU is opening an investigation into Google's competitive practices. What does this mean for the search giant?

Glaser: File this under the "things you should keep an eye on" category, which for me is a very large category. The EU is seeing that Google does have a lot of dominance in different areas from search to Android, and they are opening up an investigation to see if Google is engaging in anti-competitive practices.

They are focused on two things: Google's comparison shopping tool and also the Android operating system.

Our analyst Rick Summer does not think this is going to be a game-changer when it comes to Google's competitive advantages. Google may be forced to make some changes. For example, Rick points out that Google may not be able to force handset makers or carriers to take the bundles of applications that come with Android. You'll have to load those separately or have an option to load other things, similar to when the EU forced Microsoft to have an option for different browsers versus Internet Explorer. But Rick doesn't think that's going to make a major difference in Google's business over time.

The shares actually are trading in 4-star territory. This is a rare value in both an overvalued market and an overvalued tech sector, so you shouldn't let something like this antitrust investigation scare you away from taking a closer look at Google stock.

Stipp: Investors searching for great insights can always find them on The Friday Five. Jeremy, thanks for joining me again this week.

Glaser: You're welcome, Jason.

Still: For Morningstar, I'm Jason Stipp. Thanks for watching.