Energy and commodity companies have led the way in recent years when it comes to US earnings growth. As they tail off, can the technology sector take up the running?
Analysts expect technology to become the fastest growing sector in 2007 – following the modest 9 per cent earnings growth expected for 2006. Technology alone cannot keep S&P500 earnings growing at double-digit rates. But as the biggest sector after financial services – accounting for about 15 per cent of stock market value – it can help.
US corporate spending on information technology is projected to grow about in line with the 6-7 per cent seen in 2006. Company revenues should grow faster because of their exposure to less-mature overseas markets and consumer demand. But, after a tough 2006, margins will still need to expand to get near the 19 per cent earnings growth expected by analysts.
Some expansion seems likely. There is high operational leverage in many technology businesses. Some also have serious recovery potential. Dell and Intel, for example, both saw their margins pummelled in 2006, providing easy comparisons.
The trouble is that there was a good reason for some of the margin compression: competition. In computers, Hewlett-Packard is finally giving Dell a run for its money. Meanwhile, Intel is being challenged by AMD in microprocessors. Dell and Intel should both improve margins. But the world has changed and profitability will not bounce straight back to its old levels.
The real hope is that technology companies have learnt to be more disciplined in a world of lower revenue growth. They have started demonstrating tighter management of inventories despite last year’s blip upwards. And there are signs that some companies are rising to the challenge by cutting costs and rethinking the way they do business.
Overall, margins are likely to expand somewhat in 2007 despite fierce competition. But there will be winners and losers. The hefty earnings growth being pencilled in by analysts still looks too aggressive.