We’re reminded a little of the admonishment "be careful what you wish for" in this current market. The financial turmoil, unwinding of high energy and commodity prices and slowdown in global growth are all here as expected. Why don’t we feel more happy about it?
Obviously a market this bad drags everything down but it also calls into question fundamentals and estimates. It’s been pointed out by others like Bill Hambrecht recently in an interview that growth rates will slow but balance sheets are in very good shape. Think of the cash that leading companies like Apple and Google are swimming in.
But still we know that things "at the margin" often determine direction and sentiment for stocks and it’s clear that lower financial sector IT spending and more careful consumer spending are going to reduce the take up of technology, particularly things that can just wait a while. Our friends over at MGI put up a post that points out that while about 20% of technology spending comes from the financial sector but even more, close to 30% of "leading edge, advanced technology" comes from there. To us it means that maybe the expensive uptake of new technology products will just be a bit slower than it was going to be.
Cautious consumers and slowing global growth will certainly push purchases to lower price points and elongate new product cycles (Adobe releases CS4 next week and no matter how good it is most will probably not be eager to move from CS3 anytime soon.) No doubt $400 smart phones and $2000 laptops may give way to $150 and $1200 versions respectively. In many respects the timing of the small and cheap laptop PC will be perfect for this economic backdrop.
Current valuations seem low but of course the key question is how much of the slow down is "in the numbers" right now? We did a quick and dirty analysis looking at forecasts for the top 100 technology companies by revenue to see where we are right now.
The Top 100 have revenues of just over $1T with a total EBITDA of about $200B. Based on current estimates revenues are expected to grow 8.2% this year and 8.7% next year. These numbers are probably close to but could come down a point or so. Earnings per share growth expectations do look too high though with growth of 24% this year and 18% next. It feels like the 24% number should be cut in half and the out year would be fine from these lower levels. Athough we don’t have EBITDA estimates for all 100 companies the ones we do have show growth of 14% this year and 12% next.
Our conclusion is that there are still some negative changes at the margin that may keep valuations and sentiment in check for the near term. Since we use a longer term approach in our Intrinsic Value methodology our targets don’t change much, if at all. We probably picked a great time (October 1st) to release our model portfolio over at The Creative Destruction Fund.
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