Is Buying After a Tech Company Crashes a Good Idea?

It’s been an unusual earnings season so far. The market has kept moving higher even though many tech companies have warned. This can appear counter intuitive because tech is usually seen as a cyclical part of the economy. In other words, if tech is slowing down, then the economy will do too. Surely, if tech companies are warning, the market should be pricing in a slowing of growth rather than moving up in anticipation of stronger growth?

Pricing in a recovery?

One explanation for this is that the first quarter saw a weakness in technology spending which should be rectified in coming quarters. Indeed, I have suggested some reasons why this might be the case in an article linked here. If this argument is correct, then buying after the tech companies warn should be a good tactic. The chances are that expectations will have been lowered and the falls would have created some decent entry points.

In order to avoid the dangers of relying on anecdotal evidence and hearsay, I decided to take a bit of a methodological approach and see if the data supported the idea. 

The companies in this graph are those that warned or gave disappointing results in the current earnings season. They were garnered from the NYSE Arca Tech 100 Index. I have excluded biotech and focused on the IT hardware and software companies.

The blue lines are the stock’s performance since the day after the warning and the green lines are how they have performed against the S&P 500 since they warned. The data is current till April 20.

I think the evidence is pretty clear. Tech companies have tended to outperform the market since they warned. I appreciate that part of this effect might have been investors looking to buy stocks that looked ‘cheap’ in a rising market, but on the other hand, the evidence above is pretty broad based.

If I am right about this, then investors should start to look at potential tech company warnings as buying opportunities.

Who said what?

It’s time to look at a few of these companies to see what the specific issues were. This is useful because it helps us understand what is causing this effect.

I’m going to start with Oracle  and International Business Machines Oracle blamed its disappointing earnings on sales execution failures. This is partly a consequence of adding significant numbers of new salesmen and the inevitable disruption that this causes. In addition, its management argued that the pipeline was still in place, it was just that deals were not completed at the rate that they had expected. Oracle expects these issues to be ironed out ‘quick’ and argued that it wasn’t losing any market share.

Thinking longer term, Oracle does have question marks over some hardware product transitions and dealing with the affects that the shift to the cloud (Oracle still has substantive legacy software sales) will have on its revenue.

IBM delivered a very rare miss and I took it as an opportunity to buy some more. In a familiar refrain, it blamed sales execution but also managed to discuss the sequester, the change of Chinese leadership, the timing of Easter, and even the weather.

The good news is that -- just as Oracle did -- it argued that the pipeline hadn’t been reduced and deals weren’t lost to competition. It’s just that its sales guys just had a hard time closing deals in the quarter. The response was to do as IBM does and make some operational adjustments (workforce re-balancing) in the next quarter.

Citrix Systems also saw revenue and earnings come in lighter than expected. In addition, its Q2 earnings guidance was significantly below estimates. In actuality, it was a mixed quarter for Citrix. Its Netscaler product (an application delivery controller that competes with F5 Networks) saw good growth, but its core virtualization growth was disappointing. The latter has higher margins, so the net effect was to reduce expectations for overall margin growth in future.

It’s always worrying to see a company’s core activity slowing, but Citrix had a feasible excuse. It launched its XenMobile mobility solution in Q1 and it is entirely understandable if some of its customers may have decided to hold off purchases while they assess buying the new product. Again, Citrix outlined that its full year plans were ‘on-track’.

The bottom line

In conclusion, all three companies saw what looks like some temporary weakening caused by hesitation among customers rather than a reduction in overall spending plans. Although they all had their own reasons for disappointing, there was a common theme. All three saw their pipelines intact but customers exhibiting caution in their spending decisions. If this dissipates in future quarters (and it may do so after the media stops talking about the sequester) then buying these names, and others within technology, will prove to be a wise choice.