Bored with all the questions and commentary on what the Federal Reserve will do next? Well, you can forget about it until sometime in June, I'd say, when the Fed indicated it might trim rates another 25 basis points.
Quite frankly, we have more pressing issues to worry about now, like the June earnings season that will soon be upon us. The same set of questions that dominated our thinking about the market in February and March will surface again: Who will warn next? Have we really seen the bottom for business at this or that company? Is the quarter looking strong or weak? Will they guide expectations higher or lower for the next quarter?
Technology companies will get asked those questions with a special intensity. After all, it
as if the long bear market in the sector may be over, and probably the only thing that could derail the recovery is an unexpected collapse in second-quarter earnings. And every investor who has been trying to figure out when to jump back into the sector will be looking at the earnings numbers for clues that business has turned around at
. Is it safe? Will this bear take one more bite out of the sector?
And I'd expect those questions to be asked in a louder and more impatient voice if the technology sector manages to launch a solid rally. None of the investors holding large cash positions want to be left behind if the train is truly about to leave the station. The faster the rally, the more pressing it becomes to figure out what June quarter earnings will be and what they portend for the long term.
Why June Is Tricky
Unfortunately, the peculiarities of the June quarter will make these questions especially tough to answer. Even in normal years, the June quarter is historically the worst quarter of the year for many technology companies. So if June numbers are down from those in the March quarter, it may be just business as usual -- or it could mean that the recovery in a company's business is further off than expected. To derive meaningful clues from the June numbers about where companies stand in their business recoveries, investors will have to go beyond usual measures such as sequential earnings or revenue growth. Sticking to those standards, in fact, is likely to give an investor a completely misleading picture of the health of a company's business.
Let me quickly tell you why and then suggest a few alternative numbers to look at to judge a company's business progress or lack thereof in the upcoming quarter.
To see why June numbers can be so tricky, go back to 1999 (a very good year for tech stocks and technology businesses) and look at the quarterly numbers for Xilinx, a maker of programmable logic chips. Looking at the sequential sales growth in the June quarter of that year -- an anemic 2.6% above sales in the March quarter -- you might well have concluded that Xilinx was headed for a slowdown.
But you would have been wrong -- the numbers merely showed a seasonal pattern of sluggish growth that had no significance for long-term growth. Sequential sales rebounded to 7% in the September quarter, then grew to 10% in the December quarter and finally accelerated to 15% in the March period.
And guess what? Sequential sales growth fell back to 13% in the June quarter of 2000.
Will This June Be Business as Usual?
The seasonality of technology revenue is a long-established pattern. Many companies put off buying new inventory because they're waiting for new model and new product introductions in the fall. Many technology customers budget in six-month cycles and tend to front-end load their orders into the March and September quarters. Purchasing in general slows in the June quarter as companies anticipate that they'll need less of everything during the summer. Other companies decide to clear the deck as they gear up for big seasonal sales increases in the December quarter.
Even though the seasonality of revenue at many technology companies is a well-known pattern, it is still the major cause for the historical weakness in many technology stocks during the summer months. Enough investors sell after being spooked by seasonal declines in sequential revenue and earnings growth to put downward pressure on the technology sector as a whole. And the fear of falling victim to a summer technology slump keeps other investors out of the sector during these months, thus exacerbating the decline.
I frankly don't know if we'll have a seasonal slump in technology stock prices this year. The
had tumbled 66% off its March 2000 high as of the April 4 low, and that decline might be sufficient to overwhelm any seasonal pattern. There might be enough money waiting on the sidelines to buy into technology stocks to cancel out the traditional summer move to the sidelines by many professional portfolio managers.
But I am convinced that nobody has repealed the basic laws of business that produce the traditional slump in technology sales and earnings growth in the June quarter. Even though many technology businesses were in a sales slump as they entered the June period, I don't see any reason to think that the traditional patterns shouldn't come into play this June. Companies that traditionally reduce inventory in anticipation of new products in the fall, or huge Christmas sales, will still do so this year. Customers that traditionally have waited until they get new budget authorization in July for the second half of the year before ordering will wait again this year. I can't see anyone accelerating orders into the quarter that ends in June
business conditions are still so uncertain for the rest of 2001.
So I'd advise investors who are searching for signs that business has turned up at any technology company to pay only passing attention to sequential changes in sales and earnings from the March to the June quarters. The historical pattern says that many companies normally experience a decline in sequential growth right about now. A company that reports such a decline may only be saying that, as far as seasonal sales patterns, the current quarter is just business as usual.
The Metrics to Watch
Instead, I'd concentrate on these three numbers:
- Revenue expectations for the quarter. I know many companies are playing the expectations game right now, but I think comparing reported revenue with expected revenue can still be a useful exercise. You know how the game goes: Set expectations really low, then cheer when you beat them. Much of that game focuses on the earnings numbers, however, leaving top-line revenue expectations somewhat purer. In addition, because of their relative simplicity, it is harder to fudge revenue numbers than earnings without violating accounting rules. Take the revenue number with a grain of salt, if you will, but it is still a good sign when a company manages to meet the revenue target it set for itself. If nothing else, it demonstrates that the company has a reasonable ability to predict its own near-term growth.
Growth in orders. Since you're interested in how fast the company is growing after it comes out of its June slump, why not look at how much customers are ordering for future delivery? Wall Street analysts calculate a projection of how much future business a company will book during a quarter, so you can easily compare actual order volume with expectations. For example, the most positive number in
Applied Materials' (AMAT) - Get Report recent quarterly earnings report was the announcement that the company had booked $1.4 billion in new orders. That was way above expectations that ranged as low as $1 billion.
Book-to-bill ratio is another measure of how fast future business is growing. This ratio compares the amount of new business booked as orders to the amount of old business billed to customers. Anything under one means the company has filled more in older orders than it has booked in new orders. A ratio above one means that the company is filling its pipeline with orders for future business.
By focusing on these numbers, rather than measures such as sequential sales growth, I think you'll have a more accurate picture of the business trend at any company whose stock you own. That should help you figure out what companies have seen a true turn in their business prospects, and which stocks are potential buys.
And it should prevent you from getting shaken out of technology stocks by bad seasonal numbers just at the point where you should be buying. If the technology sector has bottomed and is moving into an uptrend, as I think it is, then any selloff on seasonally weak numbers might be a good buying opportunity before September's numbers convince everyone that business has turned for major parts of the technology sector.
Watching the right numbers could give you the knowledge and confidence to buy when everyone else is selling. And that can be very profitable.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Applied Materials.