2023-10-27 11:35:48 ET
Summary
- Tech stocks, including the "Magnificent Seven," are expected to fuel a rebound due to strong earnings growth trends.
- The information technology, communication, and consumer discretionary sectors are projected to experience high double-digit earnings and revenue growth.
- The QQQM ETF, which focuses on mega and large-cap tech stocks, is well-positioned to benefit from these trends and limit downside risk.
In my last two articles, published in May and July , I suggested growth investors buy Invesco NASDAQ 100 ETF ( QQQM ) to capitalize on the bull trend. In this article, I will discuss reasons why QQQM and growth stocks are likely to rebound after a huge decline in share price from recent highs. Solid earnings growth trends in key growth categories are one of the main reasons for the potential rebound. Other reasons include strong economic growth and a decline in forward valuation.
Tech Stocks Earnings Growth Likely to Fuel Rebound
The "Magnificent Seven", Apple ( AAPL ), Microsoft ( MSFT ), Alphabet ( GOOG ) ( GOOGL ), Amazon ( AMZN ), Nvidia ( NVDA ), Tesla ( TSLA ), and Meta Platforms ( META ), have been key drivers of the S&P 500's gains or losses over the last five years due to their significant influence on the index. Currently, these stocks account for nearly 30% of the S&P 500's weight and around 44% of the Nasdaq 100. Therefore, the financial performance of these stocks could have a significant impact on investor sentiment. Fortunately, September quarter results are coming higher than expected, increasing optimism that mega and large-cap tech stocks are likely to fuel a rebound. Software giant Microsoft and Google parent Alphabet exceeded consensus estimates for the September quarter.
Microsoft generated earnings per share of $2.99 on revenue of $56.52 billion in the September quarter, significantly topping expectations by $0.34 per share and $1.97 billion, respectively. Moreover, Microsoft's quarterly revenue is expected to hit a record level of $60.4 billion to $60.8 billion in the December quarter, reflecting a nearly 10% sequential and 14% year over year. Similarly, Alphabet also topped expectations due to strong growth in Search and YouTube revenue, which accelerated 11% and 12% year over year, respectively. Although investors reacted negatively to Alphabet's miss on cloud revenue, the double-digit Search and YouTube revenue indicates the excellent overall health of the company and an improving broader consumer internet environment. Alphabet's overall revenue soared 11% year over year, and earnings per share of $1.55 increased from $1.05 in the year-ago period. Its financial growth forecast also remains strong, with double-digit percentage growth for revenue and earnings in the following quarters.
Meta also reported street-beating revenue and earnings for the third quarter. Its revenue of $34 billion surged 23% year over year, and operating income jumped 143% to $13.75 billion due to a 100% growth in operating margin. Furthermore, the company expects healthy sequential and year-over-year revenue and earnings growth in the final quarter of 2023. It now projects fourth-quarter revenue in the range of $36.5 to $40 billion, compared to consensus for $38.87 billion and up substantially from $27 billion in the year-ago period. The retailing behemoth Amazon generated third-quarter revenue of $143 billion compared to the estimate of $140 billion while its earnings per share of $0.95 exceeded the consensus estimate of $0.60. It now expects fourth-quarter revenue in the range of $167B, up 11% compared to the year-ago period.
The trend set by Microsoft, Meta, and Alphabet indicates tech demand and the internet environment have improved for the entire tech category. Moreover, communication companies in the cable and satellite, movies and entertainment, and telecom services industries also generated solid growth. For instance, Netflix's ( NFLX ) global paid subscribers in the September quarter increased 10.8% year over year to 8.76 million, topping consensus for 6.2 million additions. As Netflix's revenue and margins improved, its earnings per share of $3.73 also outperformed forecasts for $3.48. The telecom services company T-Mobile ( TMUS ) topped expectations and raised its full-year guidance on the back of strong subscriber additions. Similarly, Verizon ( VZ ) and AT&T ( T ) also boosted their free cash flow guidance for the full year.
FY 2024 Earnings Forecast (Seeking Alpha)
FactSet data shows that the information technology, communication, and consumer discretionary sectors are likely to beat the rest of the S&P sectors in the fourth quarter and fiscal 2024. Wall Street expects a 46% earnings growth for the communication services sector in the fourth quarter. The consumer discretionary and information technology sectors' earnings are expected to grow by 24% and 13%. As shown in the above chart, these three sectors are projected to extend earnings growth momentum into fiscal 2024.
Economic Growth, Fed's Hawkish Stance and Political Instability
Economic growth has always been crucial for corporate performance and investor sentiment. Despite multiple rate hikes in 2023, the US GDP topped expectations, with third-quarter growth surging to 4.9%, the highest growth since the fourth quarter of 2021. The economic growth in the third quarter was attributed to strong broad-based consumer spending. U.S. households continue to increase spending on necessities and luxuries while spending from businesses and the government also increased considerably compared to previous periods. Nearly a mid-single-digit percentage growth in US GDP is a positive development for tech stocks and the entire stock market.
Growth Stocks Forward P/E (Yardeni.com)
The recent share price volatility has also slashed growth category forward P/E to 20.5 times, down significantly from pandemic highs of around 30 times and pre-pandemic highs of over 20 times. Moreover, as earnings of mega and large-cap tech stocks accelerate at a sharp pace, the share price upside would have a limited impact on valuations. Stock valuation becomes overvalued when shares rally without being backed by earnings growth. Forecasts indicate that the information technology, consumer discretionary, and communications sectors, the hub of growth stocks with a significant influence on the S&P 500 index, are expected to experience high double-digit earnings and revenue in the following year.
How is QQQM Well-Positioned to Benefit?
QQQM Sector Exposure (Seeking Alpha)
In my recent articles, I have pointed out several factors that make QQQM a solid ETF to capitalize on the potential bull trend. Right now, I will focus on how QQQM is well-positioned to benefit from earnings growth trends. As QQQM provides coverage of the top 100 stocks in the NASDAQ index, the ETF's portfolio is mainly composed of mega and large caps from the information technology, communication, and consumer discretionary sectors, collectively accounting for 80% of the overall portfolio. Furthermore, the Magnificent 7 stocks account for approximately 44% of its overall portfolio. The majority of mega-caps are expected to generate double-digit earnings growth in the coming quarters, which I believe will help drive the entire stock market higher, particularly ETFs like QQQM with a significant concentration in mega-cap tech stocks.
Moreover, unlike small and mid-caps that may struggle to fund new investments due to higher rates, these mega-caps have amassed a considerable amount of cash on hand. They also have the potential to generate billions of dollars in free cash flow. Therefore, mega and large-cap tech stocks are well positioned to invest in growth opportunities to capitalize on increasing demand for tech-related products and services. For instance, Microsoft generated $20.7 billion in free cash flow in the September quarter. Moreover, it has $143 billion in cash, cash equivalents, and short-term investments as of the end of the September quarter. Meta's cash, cash equivalents, and marketable securities were $53.45 billion at the end of the second quarter.
QQQM Share Price Vs. NASDAQ Index (Seeking Alpha)
In addition, QQQM's focus on mega and large caps is also likely to limit the downside in the event of a steep downtrend. QQQM's price movement compared to the NASDAQ Composite Index in the past three months indicates that mega and large caps have the potential to limit downside risk. Shares of QQQM are down around 9% compared to NASDAQ's selloff of 11%. The chart above also shows that QQQM also possesses the potential to outperform the NASDAQ index during bull runs. QQQM shares rose 45% from January to mid-July, compared to a 38% increase for the NASDAQ.
Final Thoughts
Currently, I do not see any risk that could significantly deplete the tech sector's fundamentals and trigger a huge selloff in the stock market. There may be volatility in the short term due to the fear of higher rates. However, solid tech stocks' earnings growth potential and robust economic strength will eventually increase investor confidence in risky assets and help stock prices resume their uptrend. QQQM appears to be one of the best ETFs to limit the downside and capitalize on the potential rebound. Furthermore, the ETF has a low expense ratio of 0.15% and high liquidity, which makes it a solid ETF for the long term.
For further details see:
QQQM: Earnings And Economic Growth Will Fuel The Rally