Q1 Tech Earnings Preview

Tech tug-of-war gathers steam in Q1

On the competition front, some companies not traditionally thought of as chip players are dipping their toes into that space, perhaps causing future pricing difficulty for the largest and most established names in semiconductors.

Also, cloud competition remains heavy between the top three in that product segment and others nipping at their heels. In phones, Apple continues to face a tough battle in China from domestic companies, while many U.S. chip firms struggle to get their products into that massive market due to U.S. export restrictions.

Nvidia, the poster child for AI and the hottest S&P 500 stock of Q1, still leads the tech pack despite its shares' recent retreat from March highs. However, other chip companies are growing thanks to AI.

Meta Platforms leads the calendar this Wednesday, followed by Alphabet (GOOGL) and Microsoft on Thursday.

Semiconductor earnings are more spread out, with Intel and Texas Instruments (TXN) both due this week, followed by Advanced Micro Devices (AMD) next week and Nvidia later in May. Semiconductor shares climbed 17% in Q1, but the overall S&P 500 Tech Select Sector rose just 8%, which falls below the S&P 500^® index's (SPX) growth. That mainly reflected poor performance from Apple, expected to report in early May.

"Amazon, Meta, and Microsoft are all making new highs, and the price tags tell you how investors are voting in terms of how these companies are executing," said Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research. "The question heading into mega-cap tech earnings is where do investor expectations stand in regards to growth given the recent run-up in price? Even in a beat/raise scenario, expectations determine whether or not the results justify a higher share price."

Analysts have lofty expectations for earnings per share (EPS) and revenue growth at all three of those behemoths, with AI likely driving gains to some extent but cost-cutting another factor.

AI pervades all, including cloud space

AI is an omnipresent term both on Wall Street and in the media, but it's important to understand its investment implications. AI technology can improve the function of computers so they can reason and learn more like humans and process vast amounts of data more quickly, among other uses. Advancements in semiconductor chips built by companies like Nvidia and AMD are being incorporated across multiple industries to help improve everything from online advertising to warehousing efficiency to phone performance.

AI chips also play a vital role in the cloud, allowing data centers to harvest insights about sales trends and customers more quickly.

Cloud industry revenue growth, led by Amazon, Microsoft, and Alphabet, had been slowing until about a year ago when AI excitement picked up. Now, the cloud businesses appear resurgent as AI-related demand for data grows.

Amazon's Amazon Web Services (AWS) cloud business growth might have troughed and could be bouncing back. Microsoft has been gaining cloud share on Amazon lately with big growth in its Azure cloud platform, so keep an eye on that business when Microsoft reports. Azure and other cloud revenue rose 30% in the previous quarter, above analysts' average estimate of 27%. The growth race between Azure and AWS is a long-running story in tech that still makes for exciting bedtime reading.

Microsoft also gained in the video game space last year when it bought Activision Blizzard.

AI advances also permeate the internet advertising business, where top players Meta and Alphabet duel it out each quarter. Meta's online ad business accelerated in Q4, helped by Chinese demand and advances in AI. Alphabet said Google ad revenue grew 11% in Q4, slower than some analysts had expected.

Other AI developments to watch in tech earnings include uptake on Microsoft's Copilot Pro and Alphabet's Gemini Advanced. Both are priced relatively low, but the question is whether customers are interested.

Apple sliced

All the excitement over AI this past quarter has left Apple in a tough spot trying to convince investors it can get more involved in the game. Apple's earnings in early May might play second fiddle to its June developers conference, when the company is expected to outline more detailed plans on AI. The technology could be used to create Apple Music playlists, improve search features and Siri, and power new features on the iPhone, Bloomberg reported.

In addition, the conference could shed light on the iPhone 16 expected to debut later this year, which could incorporate new AI features. iPhones do already have some AI features, like portrait mode.

Sector EPS growth seen hefty

Despite concerns about Apple's recent trouble accelerating revenue, overall tech sector earnings could come close to leading all S&P sectors in Q1 bottom-line growth, according to research firm FactSet. Analysts project the S&P info tech sector to post year-over-year EPS growth of 20.4%. That's second only to the utilities sector.

Leaving out chip stocks, the difference makers for tech earnings could be companies that aren't officially in the S&P 500 technology sector but have tech exposure through their products. Amazon and Alphabet compete closely with Microsoft in cloud computing, so even if they don't have the official S&P 500 technology stamp next to their names, any analysis of Q1 tech performance should include them.

Likes pile up as Meta trims expenses, ventures into AI

Meta is another company bulking up its AI presence. Earlier this year, Meta's CEO Mark Zuckerberg told technology site The Verge that by the end of 2024, Meta will own more than 340,000 of Nvidia's H100 GPUs—the industry's chip of choice for building generative AI. "We have built up the capacity to do this at a scale that may be larger than any other individual company," Zuckerberg said, according to The Verge. Meta will have a stockpile of 600,000 GPUs by the end of the year.

At the same time, investors appeared to cheer Meta's efforts to trim costs, which helped its stock to nearly 150% gains over the last year. In February, Meta's announced its first-ever dividend payment, as well as a 25% jump in Q4 sales and a drop of 8% in Q4 expenses. The Q4 sales pace likely won't be maintained, according to analysts' estimates compiled by Yahoo Finance. Meta is expected to grow revenue by 16% in Q1. EPS, however, are seen at $3.94, up nearly 80% from a year earlier and likely reflecting those cost trims.

Chip vertical integration gains ground

Another trend in tech is major companies developing their own chips to become less reliant on other manufacturers. Earnings season could be a time for updates.

Alphabet recently announced it is introducing new data center AI chips, one of the few alternatives to advanced Nvidia AI chips, Reuters reported. At the same time, the company announced Google Axion Processors, its first custom Arm Holdings-based CPUs designed for data centers. Axion will be available to Google Cloud customers later this year, and Alphabet promises "industry-leading performance and energy efficiency," according to a blog post. Concern grew recently about the rising impact of data center demand on the electric grid.

Apple already makes its own chips for iPhone and Mac products. "One of the most, if not the most, profound change at Apple, certainly in our products over the last 20 years, is how we now do so many of those technologies in-house," said John Ternus, who runs hardware engineering at Apple, in an interview with CNBC late last year. "And top of the list, of course, is our silicon."

Trying to produce a chip that's comparable to the market leader means lots of spending.

"Mega-cap tech has enough resources at their disposal to potentially provide some competition for Nvidia," Schwab's Peterson said. "But Nvidia has the lead for now."

Chip makers target Nvidia, fabrication

It's unclear how long it might take the chip sector's second-biggest AI player, AMD, to pull closer to leader Nvidia or for Intel to make a bigger splash with its planned new chips. The Apple and Alphabet chip efforts, too, are far from challenging Nvidia's dominance. However, more chips on the market could eventually cause this volatile sector to see supply begin to outstrip demand, perhaps sending prices down.

But AI is speeding along even as the companies hustle to keep up. For instance, Nvidia reported in its last earnings call that "inference" sales constituted around 40% of its data center business in the previous quarter. Inference means making predictions on never-before seen data, helping businesses make data-driven decisions. Some industry analysts see inference as an important second wave of the AI invasion.

At the same time, Intel is in a concerted effort to accelerate chip fabrication in the United States, with mixed results to date. It recently announced delays.

Even as cloud and AI gain ground, layoffs are an item on the watchlist. Apple is the latest big tech firm to announce layoffs, with Bloomberg recently reporting that the company laid off at least 600 workers from its cancelled automobile project. The technology sector laid off 42,442 workers in Q1, according to outplacement and career services firm Challenger, Gray & Christmas. However, that was down from 59% from the 102,391 job cuts announced by tech firms in Q1 of 2023.

Meta's Zuckerberg said last quarter he wants to "keep things lean."

For the major tech firms reporting this week, analysts expect the following, according to Yahoo Finance:

• MSFT EPS of $2.82, up from $2.45 a year earlier, on revenue of $60.77 billion, up 15% year over year
• GOOGL EPS of $1.51, up from $1.17 a year earlier, on revenue of $78.61 billion, up 12.6% year over year
• META EPS of $4.29, up from $2.20 a year ago, on revenue of $36.1 billion, up 26% year over year

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