The Strong Dollar’s (Real) Toll on Tech Stocks

While the stronger dollar certainly did hurt technology sector earnings, the currency's impact wasn't as bad as predicted, and the case for US tech remains strong.

It’s no secret that a large portion of U.S. technology companies’ sales occur overseas, given the strong international business and consumer demand for software and hardware from many of the largest U.S. tech firms.

Based on the most recent earnings data, roughly 60% of the U.S. information technology sector’s revenue comes from abroad, a higher percentage than in any other sector.

Taking this into account, many market watchers had expected that U.S. tech companies’ first-quarter earnings would be especially hurt by the stronger dollar, and the potential dollar impact was likely a big drawback keeping many investors away from the sector.

However, now that most of the companies in the sector have reported their quarterly results,  it’s clear that while the dollar certainly did hurt earnings, the strong currency’s impact wasn’t as bad as many predicted it would be.

Case in point: 66% of companies in the technology sector actually beat analysts’ first-quarter earnings expectations and 39% of companies beat on revenue (source: UBS, FactSet, 5/14/15). In addition, the technology sector overall posted the second best revenue growth among all the 10 sectors despite the dollar headwind.

How were tech firms able to generate relatively good earnings results even with the currency exposure? Besides the fact that not all sales done overseas occur in foreign currencies, technology companies have robust currency hedging strategies that helped many firms somewhat mitigate the negative impact of the strong dollar, as evident in many of the companies’ quarterly earnings calls with analysts.

At the same time, companies also were able to use shareholder-friendly policies like share buybacks and dividend increases to help boost their share prices, largely a result of technology companies’ strong balance sheets and enormous cash positions

Looking forward, there’s a good chance the dollar headwind is going to let up a bit come second-quarter results. Last year, much of the appreciation in the dollar occurred during the fourth quarter, meaning companies were likely a bit behind the curve in putting their hedging strategies in place, and first-quarter results were negatively impacted as a result.

Assuming we don’t see a similar surprise quick appreciation in the near future, given that the dollar has weakened recently, the currency impact should be less this quarter. Indeed, when you strip out the dollar impact from many tech companies’ earnings, you get even stronger first-quarter results.

So what does this all mean for investors?

Now may be a good time to consider  U.S. tech stocks. I still see upside potential for the sector and believe it’s one place to find value within the overpriced U.S. market.

Despite slightly outperforming the broader market index this year, technology stocks are still attractively priced, especially considering the sector’s decent first-quarter earnings. For instance, compared to the more defensive health care sector represented by the Dow Jones U.S. Health Care index, the technology sector, as measured by the Dow Jones U.S. Technology Index, is trading at a price-to-earnings discount of roughly 25% (S&P Dow Jones, 4/30/15).

In addition, the tech sector continues to provide some of the fastest rates of dividend-per-share growth among all the sectors, and we’re likely to see more share buybacks and dividend increases from mature established tech firms in coming months.

Exchange traded funds, such as the iShares U.S. Technology ETF (IYW), can provide access to the U.S. tech sector.


Sources: BlackRock, Bloomberg, Linked to Above

Heidi Richardson is a Global Investment Strategist at BlackRock. She is also Head of Investment Strategy for U.S. iShares. You can find more of her posts here.

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