Tech

Skittish investors await earnings from tech giants

Tech sector: A safe place to hide?
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Tech sector: A safe place to hide?

As the U.S. technology giants dive into earnings next week, they face a notably skittish investor base: The Nasdaq composite index is on pace for its worst month since the 2008 financial crisis.

Apple reports results on Tuesday, followed by Facebook on Wednesday, and Amazon.com and Microsoft on Thursday. Alphabet is slated to report Feb. 1.

The five most valuable U.S. tech companies have all tumbled to start 2016 along with the rest of the stock market. Amazon, the top performer last year in the S&P 500, is the biggest laggard of the group in January, down 15 percent, compared with the Nasdaq's 11 percent slump.

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Investors are bracing for rising interest rates and a painful slowdown in China by shedding the riskiest assets — in case you're wondering why gold prices have rallied to start the year. When it comes to tech, that means stable earnings are getting favored over growth.

"Investors want more safety and security," said Neil Doshi, an analyst at Mizuho Securities who covers Internet companies including Facebook, Alphabet and Amazon. They want to see "the ability to show margin expansion through the guidance, and the ability to rein in costs and be more prudent on the investment side, especially moving into a market with a lot more turmoil."

As far as guidance, investors will be listening for commentary on consumer demand and business spending.

Tech slide

For example, can Apple continue to sell in China without sacrificing profit? Sterne Agee CRT analyst Rob Cihra estimates that the world's second-biggest economy accounted for 25 percent of iPhones sold in 2015 and 43 percent of Apple's growth.

In China, "Apple proved it could grow last year through share gains in an otherwise down market, but macro headwinds continue," wrote Cihra, who has a buy rating on the stock and a $160 price target. The shares have dropped 8.5 percent in January to close Thursday at $96.30.

Facebook and Alphabet are counting on businesses to continue their ad spending even as budgets tighten. Considering the ongoing shift from offline to online marketing and the greater efficiency tied to Internet and mobile advertising, the top Web companies may be best positioned to weather any decline.

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According to a September report from eMarketer, Google's share of U.S. digital advertising will slip to 37.4 percent this year from 40.1 percent in 2015, while Facebook's will increase to 14.7 percent from 13.2 percent. No other company tops 5 percent.

"The apparent acceleration in retail spending allocation to online outlets and anecdotes from the advertising community make us think that ad dollar shift from traditional media to Internet will surprise in Q4, as it did a year ago," wrote MKM Partners analyst Rob Sanderson, who has buy ratings on Facebook and Alphabet. "FB is in the best position to benefit and we think likely to take more than its share of incremental ad dollars."

Alphabet faces the added challenge of breaking out its nonadvertising businesses for the first time. The Google search, display and mobile ad business accounts for all the profit, while investors will now get to see just how much the parent company is spending on initiatives like autonomous cars and extending life.

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As a value investor, the only tech mega-cap company that strategist Brian Yacktman can comfortably back is Microsoft. He's been selling out of Alphabet, because of the valuation — the stock surged 46 percent in 2015.

Microsoft is gaining momentum in the cloud and has almost $100 billion in cash that it can put to work as capital markets tighten.

"They'll be in position to take advantage of other tech companies that might be struggling and be able to snap them up," said Yacktman, whose firm YCG Investments oversees about $400 million. "They're more stable, cash rich and don't need to reinvent themselves."

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If in fact profitability is the critical metric, Amazon is the company to watch. The online retailer has defied skeptics for years, building its market value with virtually no earnings.

Amazon's operating margin in the period ended September was 1.6 percent. For the other four companies, it was above 20 percent.

Analysts expect the online retailer to report a fourth-quarter operating margin of 3.5 percent, according to FactSet, thanks to a surge in International revenue and growth in its cloud division — Amazon Web Services (AWS).

"AWS remains a major growth driver," wrote Nomura analyst Robert Drbul, who has a buy rating on the stock and an $850 price target. "We believe improved profitability appears sustainable and that dominance in the cloud computing market will continue."

With the stock up 93 percent in the past year, closing Thursday at $575.02, investors will likely have little patience for slippage.