Break out the flak jackets and metal detectors: Earnings season is upon us.
A slew of third-quarter earnings reports is heading our way, coming after several big-name technology companies' warnings left tech investors on heightened alert for signs of weakness. The earnings warnings season included
and other high-profile casualties, and now the focus turns to finding unexploded bombs lurking in tech companies' quarterly reports. If Wall Street doesn't like what it sees, it could spell more trouble for many widely held stocks.
Tech investors who are considering dumping those big tech stocks should look for fault lines; determining where they lie depends in large part on the sector. What's pivotal for the PC makers may not matter much for Internet retailers, and vice versa.
Stephen Barnes, a portfolio manager at
Barnes Investment Advisory
in Phoenix, says he'll be assessing earnings reports from technology firms to fathom whether he should scale back on his investments. "We're walking around the coal mine with a canary to see if we're running out of oxygen."
So what should you be watching for as you browse through those technology earnings reports? Here's a list:
Internet Retailers/Content Providers
It was not a summer of love for most Internet companies. Dot-coms faltered, the online advertising market weakened and investors began to view the sector with a jaundiced eye.
Since then, Internet companies have taken pains to predict when they will show a profit. This is vital, says Susan Walker White, Internet analyst at
J.P. Morgan Securities
in New York. "The interesting stories are no longer just about revenue growth," she says.
That said, White says a crucial factor this season for Net companies will be revenue growth. "We continue to believe that revenue is the best indicator of the overall health of a company and the sector," she says. "This is the most important metric we will be monitoring during the earnings season."
Another important consideration is advertising revenue, the bread and butter of most Internet companies. A slowdown in the online advertising market this year -- due in part to the fact that cash-strapped dot-com advertisers can't pay up -- is hurting the sector, so many are looking for advertising from traditional bricks-and-mortar companies.
A good bellwether will be
. The company, which is set to post earnings Tuesday, should set the tone for the sector, says White. With 90% of its revenue coming from advertising, Yahoo! is not immune, she says, but is less vulnerable -- 29 of the top 50 of the
companies are Yahoo! customers.
When examining earnings reports from large software companies, keep an eye on the revenue mix between software fees and services, says Joe Beaulieu, a technology stocks analyst at
The watchword is margins. Companies that sell software or a license to use it provide their product and additional services, such as maintenance and upgrades. The software itself is not expensive to mass produce, but providing maintenance is more costly, Beaulieu says.
Software companies are trying to maintain their software-selling revenue mix because it keeps their margins high. "In general, you want more revenue to come from license fees, or to see revenue from software licenses rise just as quickly as those from services," says Beaulieu.
Mature software companies, such as
, are looking to improve margins by shifting their revenue mix to focus on faster-growing segments, says Beaulieu.
Younger companies, such as business-to-business Internet software companies
that are growing rapidly but not showing profitability are looking for more revenue growth, he says.
, once Wall Street's comeback kid, has announced that its fiscal fourth-quarter earnings will fall "substantially" short of expectations.
has also warned about a shortfall in third-quarter earnings. Is the outlook for the PC-making business as gloomy as these warnings suggest?
Quite possibly, says Stephen Barnes. Over the next few weeks, he plans to pore over earnings reports from PC makers to see if the news from Apple and Dell is symptomatic of the industry as a whole. Apple has said that one of the reasons for their expected shortfall is a drop in orders from the education sector this year, Barnes says.
"That's their bread and butter, so if this really is the primary cause of their shortfall it could be isolated to Apple," Barnes says. "But if it's going to be an industry-wide thing it could refer to a downward flow in sales across the whole technology sector, and we'll scale back our investments accordingly."
Also key to assessing PC makers is a company's inventory-to-sales ratio says Barnes. "If it goes up, they are having problems selling their products. If it goes down, perhaps they're having problems meeting demand and might lose money when they write off unsold inventory, and that will influence the stock."
is busy building the backbone of the Internet, but it has competitors.
These companies are scrambling for market share in the hottest growth areas within the networking sector. They are providing the routers and switches that power the Internet and make it faster, and so it's worth examining company earnings reports to see which ones are taking the most.
For these companies, cornering the hot pockets of networking plays a paramount role. However, because many companies may not break out performance in each of these areas, it's a good idea for investors to keep a close eye on what analysts and Wall Street experts are saying about the earnings results. Often, these comments come when the companies hold conference calls after the earnings are released.
For a fast-growing sector like Internet infrastructure, another issue to look out for is capital expenditure. If the telecommunications companies that utilize the products of JDS Uniphase and others start to pull back on how much they are spending, these networkers will feel the pinch, says
Kevin Landis of
PC makers in trouble? Then spare a thought for the companies that make the bits and pieces that go inside them.
Take semiconductor companies. Intel was the first to announce a third-quarter earnings shortfall last month. Microprocessors made by companies like Intel make PCs work, as well as power cell phones and other small devices. Problems within PC makers and other hardware companies usually turn into headaches for semiconductor companies.
When faced with an earnings report from a semiconductor maker, keep a close eye on inventory, and scan the fine print for any hint of high order rates, comments on lead times, backlog and other forward-looking information, says Fred Hickey, editor of
The High-Tech Strategist
newsletter. The numbers for the quarter will probably be very good, but they will be meaningless, he says. If "inventory is huge, there is a glut, and that's bad."
According to the
Semiconductor Industry Association
, an industry trade group, orders of semiconductors for August were up 52%, the highest year-over-year growth since last September. However, orders of PCs and other devices are not growing as fast, says Hickey, so they will start to slash orders and there will be a downturn.
"We'll see it in numbers from
, and from the PC makers."