Information technology stocks in the S&P 500 Index (SPX) delivered a massive 22% EPS increase year-over-year for the third quarter, a stunning 11 percentage points better than analysts' consensus estimates, according to Goldman Sachs Group Inc. (GS). This kind of earnings performance, if it continues, is likely to fuel tech stocks to higher altitudes for the rest of this year and in 2018.
Just as impressively, 81% of these companies beat EPS expectations by more than one standard deviation, their best performance in more than 19 years. Overall, EPS for the S&P 500 grew by 7%, 2 percentage points above consensus, and 90% of that earnings surprise was due to the tech sector. These findings were published in Goldman's U.S. Weekly Kickstart report dated November 10. (For more, see also: Why Big Investors Are Doubling Down on Pricey Tech Stocks.)
The four largest U.S. tech stocks, as Goldman categorizes them, accounted for 50% of that 2 percentage point EPS surprise for the S&P 500: Facebook Inc. (FB) Apple Inc. (AAPL), Microsoft Corp. (MSFT), and Google parent Alphabet Inc. (GOOGL). Add in Amazon.com Inc. (AMZN), technically classified as consumer discretionary due to its core business as an online merchant, and the five FAAMG stocks collectively increased revenue by 21% in 3Q 2017, their biggest year-over-year growth rate since 1Q 2012. Goldman Sachs equity research analysts expect full year aggregate sales growth for the FAAMG stocks to be 19% in 2017 and 20% in 2018. By comparison, the consensus estimates for total S&P 500 sales growth in 2017 and 2018 is 7% for both years, Goldman indicates. (For more, see also: 4 Reasons These Giant Tech Stocks May Be Unstoppable.)
Other Techs Follow
Strength in the tech sector goes far beyond the FAAMGs, Goldman notes. As a whole, S&P 500 tech stocks increased revenue by 17% year-over-year in 3Q 2017, 2 percentage points above consensus. Only energy stocks, with a 19% increase, did better. Moreover, the techs increased their collective profit margins by 72 basis points, handily beating analysts' consensus projection that their margins would decline by 74 basis points.
Looking ahead, Goldman's economists believe that rising wages are a key downside risk for corporate profit margins. While the median S&P 500 company has labor costs equal to 11% of sales, the ratio is much lower for various leading tech firms. For Facebook, Apple, and Alphabet, their respective ratios of labor costs to sales are 5%, 2%, and 7%, per Goldman's calculations. On the other hand, both government officials and the general public are raising concerns that the big tech companies are too powerful, and thus should be reined in or even broken up. (For more, see also: FANG Stocks Face Same Dark Fate as Microsoft, IBM, AT&T.)
Leader and Laggard
Among the other 10 sectors, energy and financials stand out, for opposite reasons. Energy led all sectors with year-over-year growth rates of 156% in EPS, 19% in sales, and 259 basis points in profit margins. The price of benchmark North Sea Brent crude oil has increased by about 13% so far in 2017, creating much of the impetus for these big improvements, Goldman says.
At the other end of the spectrum, financial stocks suffered the biggest EPS decline, -8%. Nonetheless, 52% of financial firms beat estimates, while only 12% missed, per Goldman. Drill down a layer deeper, and it becomes apparent that hurricane-induced losses in insurance (EPS -67% YOY) and diversified financial services (-28%) offset strong earnings gains for banks (+9%), capital markets firms (+14%), and consumer finance companies (+9%), Goldman observes. Within diversified financial services, credit card companies and asset managers are among the biggest components, according to Value Line Inc. (For more, see also: Stock Market Could Plunge On 'Very High' Risk Banks.)