This should not come as a huge surprise, insofar as Forrester Research predicted an increase in business tech spending in 2010 after a decline in 2009. But is it too late to buy into this tech rebound? And how sustainable is this earnings growth?
In short, it's not too late to get a piece, but the earnings growth will likely top out and then go back down unless a big new technology wave gets started soon.
Intel Beat Expectations Because Companies Are Finally Replacing PCs
Even considering the predicted increase in tech spending, Intel's second-quarter earnings beat expectations. In the quarter, Intel's net income of $2.89 billion rose from a loss while its $10.77 billion in revenues spiked 34% from 2009. Intel's 51 cents a share earnings were 19% more than analysts expected, and its sales came in 5% higher, according to The New York Times. Moreover, Intel forecast third quarter revenue between $11.2 billion and $12 billion, above analysts' estimate of $10.92 billion.
What was behind this boffo performance? Corporations had delayed buying new PCs for between four and five years, and they are finally deciding that it's time for new machines. That wave of PC replacement is likely to continue for at least the next quarter, if not longer. And since you can't buy a PC without a central processing unit, many of which are made by Intel, that replacement cycle is good for Intel's business. Moreover, the odds are really good that the new PC will come with a Microsoft (MSFT) operating system and application software suite.
This boost in spending was foreseen earlier this year. As Investor's Business Daily reported in April 2010, Forrester Research predicted that U.S. IT spending would rise 8.4% to $550 billion in 2010 following an 8% decline in 2009. Such a spending surge ought to help other big technology companies like IBM (IBM) and Cisco Systems (CSCO) as well.
All this unleashed technology demand is going to boost IT company earnings much faster than the U.S. corporate average -- and that average growth is likely to be high. Back in April, Thomson Reuters predicted that IT firms in the S&P 500 would report $31.6 billion in profit for the first quarter, up 53% from 2009 -- the third-highest dollar level since 1998, when it began to track the numbers. And it projected overall S&P 500 earnings would be up 39%, according to Investor's Business Daily.
Corporations certainly have plenty to spend, after hoarding cash during the financial crisis. According to Moody's (MCO), in the first quarter of 2010, cash at U.S. non-financial corporations was up 27% from 2007 to $1.84 trillion -- its highest level as a percentage of total assets in 50 years.
Placing Your Bets on Tech Rebound
Is it too late to take advantage of this run? If you decide to plunge into tech stocks, it's worth considering the price/earnings to growth (PEG) ratios of some of the leading companies. In my book, a PEG lower than 1.0 means a stock is trading cheap. Here are six leading IT companies ranked from lowest to highest PEG (based on Zacks analysts' consensus estimates):
- Microsoft: PEG, 0.96 based on a P/E of 12.5 on 13% earnings growth to $2.32 in 2011
- Dell: PEG, 1.07 based on a P/E of 17 on 15.8% earnings growth to $1.47 in 2011
- Hewlett: Packard: PEG, 1.17 based on a P/E of 12.9 on 11% earnings growth to $4.98 in 2011
- IBM: PEG, 1.32 based on a P/E of 12.7 on 9.6% earnings growth to $12.34 in 2011
- Cisco Systems: PEG, 1.36 based on a P/E of 19.2 on 14.1% earnings growth to $1.59 in 2011
- Intel: PEG, 3.49 based on a P/E of 18.5 on 5.3% earnings growth to $1.97 in 2011
The other relevant question is this: Can technology companies sustain this earnings growth? As I wrote last month, a decade-long revival such as we've seen in the past depends on the creation of a wave of new technology -- like the PC when it was first introduced in the 1980s or the Internet in the 1990s. But the current wave of PC replacement is cyclical, not revolutionary. This means that once most companies have replaced their PCs, their IT spending growth will slow down again.
If, in the next year, a new technology wave gets going -- it might involve so-called cloud computing, which lets companies run their operations on someone else's computers -- much more of that $1.84 trillion in corporate cash could find its way into the coffers of the IT companies producing that revolutionary new technology.
In the meantime, it's not too late to profit from the shorter, but still intense, PC replacement cycle.