Tech stocks have been among the best performing stocks over the last several years. That trend is likely to continue. But the simple fact is that there are a handful of names that have dramatically outperformed the market while many names underperform.
Sector rotations in and out of microchips, software and hardware names send investors running for the hills. The volatility is hard to stomach for investors, let alone traders. Still, the sector spawns new hope of the next big thing or an emerging cash cow.
More recently, this market has flashed confusing signals. As we prepare to look at which tech stocks have the best chances for future success, we have to look at some of the recent moves that have investors guessing which way the market will go.
GOOG and TWTR
The most recent earnings season could be characterized by profit-taking near the top and a lack of bullish conviction. If the bulls wanted to chase stocks higher, then new highs would have been a near-daily occurrence throughout the recent few months.
When we think of tech stocks, of course FANG comes to mind. In terms of recent earnings performance we see a mixed bag from that select group of names. Netflix led the way with disappointing subscriber growth and Facebook followed that with privacy concerns.
Alphabet and Twitter both posted better than expected results that sent shares soaring following earnings. There were also dozens of smaller tech stocks that posted good quarters and gave some bullish outlooks. While big cap tech gets a lot of the headlines, it’s the smaller stocks that can sometimes produce the biggest surprises.
Importance of Earnings
Earnings are what drive stocks. Yes, the charts and timing all play a role in what happens, but at the end of the day it is all about the earnings. We at Zacks have developed a system to tell us which stocks are seeing the best earnings estimate revisions. The Zacks Rank will give you that heads up, but to find the truly best stocks, you have to do more homework than that.
A key to understanding why the estimates are moving up is found in analyst reports. The Zacks Rank looks at the estimate changes from all the major brokerages, but the devil is in the details.
Just like the recent moves in GOOGL and FB and TWTR, we can make some broader assumptions about the tech space and therefore get into the best position possible to ride this market through year end.
Where Growth Is Great
Not all growth is valued the same by all investors. This concept really suggests that only the best type of growth is worth investing in. The recent swings in the market tell me that investors are really interested in the growth from only certain tech names.
Stocks with pricing power have seen stronger moves higher than those without. The concept is simply that demand is still very strong across the board, but that pricing power can help the company expand margins and those fatter margins lead to larger profits.
We really start to see the impact of pricing power and strong demand when tech names are more fully addressing the higher end of the customer base they serve. FB and NFLX are simply not in the group, as they look to maintain what they have as opposed to offering a higher end product. AAPL and its $1000 phone, which was panned by many at launch, now looks to be a margin driver for the company.
Be Conscious of the Comps
Pricing power and addressing the higher end may not be enough to ensure that you have found a lasting investment in the tech space. As we wrap up the second quarter results and begin to look forward to what the third quarter will bring, we are reminded of how strong that quarter was as well.
Headline after headline around that earnings season suggested that the bears had one less leg to stand on…and this was among their strongest arguments. The idea was that the solid earnings performance reduced valuations across the board, a long held battle cry of the shorts.
Those strong reports from the past have a way of being a problem in the future. They will present some tough comparisons in the coming quarters, so there could be some “headline shock” coming for multiple stocks. Finding good stocks that don’t have this roadblock will be critical to success.
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