Software Rises Above Semiconductors And Hardware As Tech Heads Into Earnings Season

No sector got spared in the recent COVID-19 pandemic-related plunge. That said, some appear to be weathering the storm a bit better than others heading into Q1 earnings season, and one of the more solid performers might be Information Technology.

As earnings begin, we’re likely to see the pandemic’s effect by way of negative revisions and downgrades across all sectors, even tech. But investors might find some solace in knowing that tech stocks have a few inherent strengths that perhaps played to the sector’s advantage in this unprecedented time of crisis.

Technology Sector Takes the Lesser Hit

Let’s start with the S&P 500 Index (SPX) to get a snapshot of what’s happening overall. Last December, the earnings growth forecast for Q1 stood at 4.4%, according to market research firm FactSet. That figure has since been revised to -10% (as of April 9). If that comes to pass, it would be the worst earnings season in more than a decade.

In contrast, FactSet forecasts a slight Q1 earnings boost of 0.7% for the tech sector, putting it in the top-five of the 11 S&P 500 sectors for the quarter. At the industry level, Software, now barely in the negative, leads the pack, while Semiconductors and Hardware—both industry leaders in Q4 2019—are now tech’s biggest performance laggards.

The Virtual Gets a Bit More ‘Real’

Technology’s performance amid COVID-19 setbacks could surprise some people.

If people can’t go to work or school because of social-distancing orders, they’ll have to congregate in virtual meeting grounds. So we could see an increase in demand for virtual communications platforms and software, plus cloud and data center services. This opens up opportunities for tech companies positioned to take advantage of this brave new “work-at-home” world.

If people can’t go to movie theaters and live events, get together with friends, or conveniently shop for goods out of fear of contagion, then tech-heavy companies such as Facebook, Inc. FB, Netflix, Inc. NFLX, and even Amazon.com, Inc. AMZN may experience a boom in demand. Granted, these companies aren’t officially part of the Tech sector, but they certainly rely heavily on tech, so often see their fortunes rise and fall along with Tech.

On the flip side, some tech or tech-driven companies like Apple, Inc. AAPL, Microsoft Corporation MSFT, and Alphabet, Inc. GOOG GOOGL that rely on Chinese factory production may have to deal with disruptions to their supply chain.

In any case, the coronavirus impact seems to have highlighted opportunities that can change the course of technology: Namely, diversifying supply chain locations, developing top-of-the-line virtual enterprise solutions, and beefing up cybersecurity.

Software Outperforms

Microsoft (MSFT), software’s biggest player by market cap, appears to be recovering from its month-long slide, having bottomed out on March 23 at $132 a share. According to MarketWatch, the software giant warned that it may not meet its previous quarter’s guidance due to COVID-19. Even though product demand remains high, supply chain disruptions—since parts are manufactured in China—have slowed MSFT’s capacity to meet that demand as previously expected.

Taking a longer-term view, analysts at research firm CFRA forecast a three-year compound annual growth rate of 14% for the company, singling out MSFT’s Azure cloud-computing platform and its Office software as two segments they anticipate driving growth. Despite the current risks facing the global economy due to COVID-19, the analysts feel confident that MSFT’s strong balance sheet should help offer “downside protection.”

In an interesting turn of circumstances, Zoom Video Communications ZM, found itself thrust into the spotlight as several businesses and schools began using its virtual communication platform for virtual meetings and classroom sessions.

ZM shares bucked the downtrend, skyrocketing 140% from $68.72 per share on January 2 to a high of $165 on March 23 before tumbling back to $108 over the following weeks—then rising again to $140. Perhaps it was the company’s unexpected demand and workload, but the massive flood of consumer use exposed a few cybersecurity issues that appeared quite severe—enough to mire the company in a number of consumer lawsuits. Perhaps the most recent rally has investors thinking ZM has a way forward in terms of working the kinks out. After all, this was arguably the platform’s first true “stress test” in terms of usage.

Letting the Chips Fall as they May

Chips are typically produced early on in the supply chain process. And this is one reason why the market looks to semiconductor performance as a leading economic indicator—chipmakers often respond to and forecast future business and consumer demand.

The Philadelphia Semiconductor Index (SOX) managed to pull off a 33% rebound from its March 18 low, lifted in part by some of the industry’s biggest players including NVIDIA Corporation NVDA, a recently-upgraded Intel Corporation INTC, and Advanced Micro Devices AMD.

According to a recent CFRA Sector Watch report, there’s an 85% probability for overall Semiconductor sales to fall for the second year in a row. But not all chips are the same. Those with more exposure to business spending, say for cloud computing and enterprise data centers, may perform better in the current environment, especially considering the number of employees working from home in the midst of the lockdown. This may benefit INTC and AMD, two of the biggest players with sizable exposure to business spending.

On the other hand, consumer spending on smartphones and other electronic consumer devices may not see much of a surge until the holidays; the exception being game console devices (a good way for families to escape while couped up at home). Auto sales may not see much of an uptick as well, considering the slowdown in factory production and sales. For these reasons, chipmakers like NVDA and even Texas Instruments Incorporated TXN may not fare as well as their enterprise and cloud-computing counterparts.

Hardware Hit the Hardest

Last quarter, hardware was the second highest industry performer following chipmakers. With most shops now closed, partly triggering a decrease in consumer spending, the industry has now sunk, however temporarily, to the bottom of the barrel.

As hardware’s biggest player by market cap, AAPL shares enjoyed an impressive 56% run in 2019. But like most of the market, AAPL shares have fallen from its highs. Despite hundreds of its retail stores shuttered since January and several of its supplier factories shut down in China, AAPL enjoys a high customer retention rate and strong free cash flow, according to CFRA analysts. Adding to this a diversified basket of new service offerings—video streaming, gaming, magazine subscriptions, and healthcare applications—and the company may see enough growth prospects to weather the current storm.