IBM's 3Q earnings and 4Q outlook will help investors determine what's next for tech stocks.
October 15, 2004: 4:19 PM EDT
By Paul R. La Monica, CNN/Money senior writer
NEW YORK (CNN/Money) - Tech investors are pining for an explosive fourth-quarter move in order to wind up with a second consecutive year of gains.
The Nasdaq only needs about a 5 percent surge between now and the end of December to finish in the black. But so far, the market is still waiting for a catalyst to get the tech sector heading substantially higher.
A solid third quarter report from tech conglomerate IBM on Monday could be such a catalyst.
That's because Big Blue, more so than any other large tech firm, has a presence in just about every aspect of the sector's food chain. The company is a leading manufacturer of personal computers, servers and storage devices, one of the world's largest software developers and the top tech consulting firm.
Analysts expect IBM to report earnings of $1.14 a share, up 12 percent from last year, on sales of $23.4 billion, a 9 percent increase from a year ago. But Wall Street will be paying even closer attention to what the company says about the fourth quarter.
The final three months of the year tend to be big business for techs thanks to increased consumer demand around the holidays. There's a boost in tech spending by corporations looking to flush out their yearly budgets, too.
"I would look for IBM to still have decent growth in the fourth quarter. It's usually a pretty good quarter as far as tech spending goes," said Wendy Abramowitz, an analyst with Argus Research.
Optimistic in July, but what about now?
IBM's chief financial officer was relatively upbeat during the company's second-quarter conference call, saying that customer spending was improving.
At that time -- mid-July -- the company said it expected to meet the consensus earnings and sales targets for 2004. But since then, executives from fellow tech giants Cisco Systems, Hewlett-Packard and Oracle have issued more guarded outlooks about the state of corporate tech demand.
With oil prices recently spiking to near $55 a barrel, this has sparked even more concerns about a slowing economy and what impact that would have on IT spending. In addition, the dollar has strengthened a bit, which could hurt IBM since the company generates more than half of its sales overseas.
So it remains to be seen if IBM can meet fourth quarter earnings estimates of $1.74 a share and revenue projections of $27.4 billion.
A lot will depend on how IBM's various business segments perform. In the second quarter, IBM posted strong results from its hardware division -- sales grew 12 percent from a year ago. Abramowitz expects another robust quarter here.
But IBM's more profitable business segments, services and software, didn't fare as well in the second quarter. The services division (consulting and outsourcing) reported a sales gain of just 7 percent from the same period last year. Abramowitz is predicting a double-digit revenue increase for the third quarter, though.
Software posted a slight year-over-year decline in sales and Abramowitz said another quarter of flat revenue growth is likely.
The software sluggishness is particularly worrisome, since that division accounted for more than a third of IBM's pre-tax operating income in the second quarter.
"I would like to see a recovery in their software business. That would be encouraging," said Adam Adelman, senior portfolio manager with Philippe Investment Management, an institutional firm that owns shares of IBM.
2005 estimates have to head higher
But Wall Street is worried that corporate demand for all of tech, and not just software, is starting to cool after a very strong 2003 and a good start to this year. That has been reflected in IBM's stock.
It has been a wild ride for Big Blue and other tech stocks during the past two years.
Shares of Big Blue surged more than 20 percent last year on hopes of strong fundamentals in 2004. The stock's momentum continued in the early part of this year, with IBM (Research) tacking on another 8 percent through mid-February to briefly trade above $100 for the first time since April 2002.
But because of the concerns about a profit slowdown, the stock is now 15 percent off its 52-week high (down 8 percent for the year).
Investors are fretting about growth. Earnings are expected to increase 15 percent this year, but only 11 percent in 2005. Harry Blount, an analyst with Lehman Brothers, said he doesn't think IBM will give a 2005 forecast but he does expect the company to maintain a more optimistic tone than other tech companies have recently.
"Overall, IBM will paint a picture that demand is solid. It may not be as robust as earlier in the year, but things haven't fallen off a cliff," said Blount.
Still, unless earnings estimates for next year head higher, it might be tough for the company to justify its current price. IBM trades at about 15 times earnings estimates for 2005. While Adelman says this is a more attractive valuation than earlier in the year, he hesitates to call it a bargain given that IBM's long-term estimated growth rate is just 10 percent.
IBM is certainly not alone in this predicament. Many other tech stocks now appear to be reasonably valued, with companies like Intel (Research), Cisco Systems (Research) and Oracle (Research) all trading at less than 20 times next year's earnings estimates.
But tech is a business where investors are willing to pay higher multiples when earnings estimates are rising.
So if IBM can prove to Wall Street analysts that they should take up their 2005 numbers, then that long-awaited tech rally for Big Blue and the rest of tech may finally come to fruition. If not, then the Nasdaq's winning streak may end at 1.
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