There's nothing like a sudden sell-off in technology shares to add a little spice into earnings season. It's never a good sign when stocks begin tumbling well before the first tech giant of the season reports its numbers. That first report will come from Google later this week, and it could set the tone for the next several weeks for tech shares.
Since March 10—interestingly, the same day the Nasdaq Composite peaked 15 years ago—tech stocks have been suffering a prolonged selloff. The Nasdaq has fallen 7% while the S&P 500 declined a more modest 2%. But that doesn't begin to illustrate the damage in individual stocks, many of them seen as the growth leaders in Silicon Valley these days.
Google, for example, is down 12% during that time. Amazon is down 15%, Facebook is down 16%, and LinkedIn is down 19%. Still others haven't fared even that well. Twitter has lost 23% of its value, Netflix 26% and Pandora 32%. All of these are stocks that have surged over the past year, and most are still up by a considerable margin over the previous 12 months.
But those rallies mostly came on the back of unexpectedly strong revenue growth over the past year—particularly in mobile. Investors began to doubt the ability of mobile devices to deliver solid ad revenue, but last summer companies like Facebook, Pandora and Google showed that it could be done. And demand for their stocks suddenly grew.
This year is a different story. For one thing, there is a sense that the quarter could be a disappointing one for all industries, not just technology. At the end of 2013, analysts expected S&P 500 earnings to grow 4.4% in the first quarter of 2014. They've since revised that estimate down to flat earnings growth. Earnings are expected to grow more slowly than revenue for the first time in nearly three years (when profits were growing closer to a 12% rate). None of that would make for a celebratory quarter.
So why has tech been hit harder as these estimates have been ratcheted down? After all, one of the things that made tech shares popular over the past year is that many companies seemed primed for earnings growth. The selloff came as that broader concern about slower earnings converged with lingering concerns about overvalued tech stocks. The Nasdaq traded at 35 times average earnings of its component stocks, while the average PE ratio for the S&P 500 Index was 17.
All of this makes for a potentially interesting few weeks in technology earnings. On the one hand, if selling off tech shares has set the bar low for tech leaders, they could easily surprise to the upside. On the other, companies are left with little tolerance for disappointment. Pleas for investors to wait a few more quarters for promised growth may be met with indifference.
Google is often among the first major tech companies to report earnings. Although the company's main revenue stream is search ads, it's seen as a proxy for the health of the overall industry: how advertisers are feeling about spending, whether ad rates are rising or falling, how expansion into global markets is going.
Analysts are looking for Google to post an 11% increase in revenue in the first quarter to $15.5 billion and for EPS to grow 10% to $6.39 a share. That's a flat performance for a company that saw its stock rise 38% over the past year, even after its recent declines. But Google is pushing into new areas of content (Play), e-commerce ads (product listing ads), and mobile (Google's myriad mobile apps). Together they could accelerate growth.
Google's report may also give insight into how the income statement will look without Motorola Mobility, the smartphone maker that Lenovo agreed in January to buy for $2.9 billion. Offloading manufacturing costs will likely push operating margins higher. But there could be bad news as well: Last quarter, Google hinted at softness in its mobile ad pricing, and further deterioration could become an area of concern for investors.
Such are the risks of Google and other growth-oriented tech leaders. When the market is going up, risk is seen as an opportunity for big rewards. When it's going down, it's seen as, well, risky. For much of the past year, risk has been something tech investors have welcomed. By the end of the month, we'll have a better idea of which perspective prevails. And the first hint will come later today.