Information technology sector earnings were surprisingly positive in the second quarter despite poor sentiment. Investors viewed the group as facing significant headwinds including soft demand due to the strong dollar, and cyclical weakness. Bucking expectations, earnings-per-share ended up growing by 2.2% in Q2, significantly better than initial estimates for a decline of 5.2%.
The unlikely contributor to upside in the quarter was the semiconductor industry group. Growth was 14.4%, compared to a 2.8% expectation initially.
Benefiting the quarter was strength from the Internet of Things, data center, and mobile. Encouragingly, China data points appear to have improved, specifically on the smartphone side. And the Apple inventory supply chain issues proved to be in the process of subsiding as orders increased ahead of the iPhone 7 launch. Thus, guidance was better than anticipated.
S&P 500 Information Technology EPS Growth Year-Over-Year
Source: S&P Global Market Intelligence
Semiconductors were a driving force in upward revisions to Q3 and Q4 technology earnings estimates and the semiconductor stocks were rewarded (+11.5% since the start of July). From a valuation perspective, the semiconductors trade at a 33% discount to its ten year average despite the recent price appreciation. At a 15.1x price-to-earnings ratio (P/E) on a next-twelve-month basis, it is trading at a more attractive valuation than the technology sector, which has a P/E of 17.1x.
We believe that several opportunities remain within technology and specifically semiconductors. Demand for semiconductors is normally a sign of economic growth. As the economy and consumer continues to improve, so should the business prospects (and the stocks of) for companies comprising this sub-industry.