Wall Street looks back to the future

In search of robust corporate earnings growth in 2006, Wall Street is thinking retro: the technology sector.

Technology shares which soared in the late '90s, then swooned in 2000-02 have led the stock market's powerful advance this year amid rising expectations for healthy fourth-quarter profit reports and for more of the same in the new year.

Although energy companies are expected to post the biggest year-over-year gains when fourth-quarter reports begin to roll out in earnest next week, that sector's strength may no longer be a surprise to investors, given record energy prices for most of the last year.

By contrast, the growth potential in the tech business was highlighted by some of the product rollouts at the International Consumer Electronics Show in Las Vegas this month, and by Apple Computer's surprise announcement that its fourth-quarter sales soared to $5.7 billion up more than 60 per cent from a year earlier.

What's more, because many US companies are flush with cash, there are high hopes for continued growth in corporate capital spending on tech equipment and software in 2006.

"Earnings expectations for tech look pretty solid," said Dirk Van Dijk, research chief at earnings tracker

Zacks Investment Research in Chicago.

Technology companies in the blue chip Standard & Poor's 500 index are expected to report a 17 per cent year-over-year gain in fourth-quarter earnings, on average, based on Wall Street analysts' estimates compiled by Thomson Financial in Boston.

Among 10 major industry groups, that would be second only to the energy sector's anticipated 45 per cent profit gain.

For 2006 the tech sector's expected profit growth rate is 16 per cent, compared with 14 per cent for energy and 13 per cent for the average blue-chip company, Thomson data show.

The sector expected to show the biggest year-over-year earnings gain in 2006 is the so-called consumer discretionary group, which includes auto makers. Analysts' consensus estimate is for an 18 per cent increase in profit. But that would be a rebound from dismal results in 2005. The tech sector, by comparison, has posted strong earnings growth every year since 2003.

Yet many investors have been suspicious of tech stocks since the 2000-02 crash that followed the wild late-1990s bull market. This year, however, money has been pouring into the shares.

Despite a modest pullback in the market in recent days, Apple's stock is up 19 per cent this year, disk-drive maker Seagate Technology is up 15 per cent and computer networking giant Cisco Systems is up 11 per cent.

Corporate earnings growth overall naturally is decelerating as the US economic expansion rolls on. S&P 500 companies' average year-over-year profit gain peaked at 20 per cent in 2004, according to Thomson.

Although the low-double-digit S&P 500 growth rate expected this year still would be a decent showing, the slowing pace gives investors more of an incentive to hunt for companies that have the potential to surprise with better-than-expected profit results. David Garrity, research director at investment banking firm Investec in New York, said the fundamentals of the tech sector suggest that many companies could be poised to beat analysts' current earnings estimates. "It's most likely that upward earnings revisions are going to be seen in tech," he said.

Indeed, with earnings reporting season about to kick off, one trend in tech stocks' favour is that the earnings previews the industry has given for the fourth quarter have been more upbeat than downbeat, compared with a year ago.

A total of 177 technology companies already have said they expected to meet or beat analysts' fourth-quarter estimates, up seven per cent from the 165 companies that had given such upbeat previews at this point a year ago, according to Thomson.

Meanwhile, 162 tech companies have said they expected to fall short of analysts' estimates, down 26 per cent from the 220 that had warned at this point last year. Still, some money managers say the surge in tech shares this year may have dimmed their prospects for the rest of the year, because the prices already may be reflecting strong profit growth.