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1/16/2004
11:52 AM
William Schaff
William Schaff
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Taking Stock: Expect Unexpected In Earnings Parade

If upcoming fourth-quarter earnings don't show growth above 20%, William Schaff says, many investors will be disappointed. And we know what happens when a tech company disappoints.

Nothing like starting the new year with a bang. The Nasdaq 100 index was already up almost 4% through Jan. 13, not too shabby after a strong year. Maybe it's the "January effect" everyone talks about as investors look to reinvest money for a new year. Maybe it's all the cash on the sidelines finally deciding to take a chance on technology again.

In any case, most investors know that expectations for tech-company profits and earnings are quite robust. For many tech stocks, if upcoming fourth-quarter 2003 earnings don't show growth rates above 20%, I expect many investors will be disappointed. And we know what happens when a tech company disappoints.

Accenture, an IT-services and consulting company, had more than a little case of indigestion with its earnings report. Earnings were pretty much on par with expectations, with revenue growth coming in as expected but offset by lower-than-expected gross margins of 34%, down from 39% last year. Much of this was attributed to three underperforming contracts, a disappointment for what I see as a fiscally well-managed company. The outsourcing trend was still evident as bookings for outsourcing contracts rose by 350% year over year to almost $3 billion.

SAP, a leader in enterprise-resource-planning software and related vertical-industry applications, disclosed weaker-than-expected sales for its fourth quarter last week. The stock immediately went down 3%, a relatively small share-price hit for such a large company. Clearly, there was some anticipation that this might occur, and it helped that, on a constant-currency basis, the revenue numbers didn't look so bad, in my opinion. The effects of a weak dollar were offset by better-than-expected U.S. sales.

Last week's big earnings announcements started off with Intel and Yahoo. Intel's revenue was $8.7 billion, up 22% from a year ago, and above the upper end of revenue predictions. But, just as important to most investors is the company's ability to expand its gross margin. Margin leverage is key to justifying Intel's higher share price. The more the margin can expand during this economic cycle because of prior capital expenditures, the higher the company's potential profitability. The greater the potential for higher peak earnings, the greater the potential for shareholders to be rewarded by higher share prices. It looks to me as if the market is somewhat disappointed by Intel's forecast of a decline in revenue and gross margins for the first fiscal quarter. Typically, Intel experiences a drop in revenue from fourth quarter to the first, but some analysts had hopes of a flat-to-up quarter.

Meanwhile, Yahoo is one of the bellwethers for Internet investments. Increasing demand for online commerce and advertising have driven the valuation higher. Transaction volumes were substantially higher and in line with online sales growth rates in the United States of 30% to 45%. Tech investors continue to expect higher revenue and profit forecasts going forward. For their sake, let's hope it's so, because it's my opinion that pricing is almost too high once again.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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