Sector Watch: Tech, Oil, Aerospace & Conglomerates

In my weekly Earnings Trends report, I rank the 16 economic sectors on a wide variety of earnings and sales metrics. The report just looks at the 500 firms in the S&P 500, not the whole Zacks Universe. However since it is organized by the individual metric, such as Annual Earnings Growth or P/E, it can be hard to get an overall picture of a given economic sector.

This is the third post in a series that tries to rectify that. Since there is a lot to write about in each sector, I will cover four sectors in each post. The data is based on the bottom-up consensus estimates for each stock in the S&P 500 and is then aggregated into the economic sectors.

As a base I present the data for the S&P 500 as a whole (The S&P data in this report is from the close 3/4/11, while the data for the review of the first 8 sectors, posted last week is from the close 2/24/11. The sector level data here is also of the 3/4/11 close, while the sector data in the earlier overviews was also based on the 2/24/11 close.)

S&P 500 (98.2% in)

To get an idea of how each sector will do, it is useful to have a common benchmark, such as the entire S&P 500. For the S&P 500 as a whole, earnings were up 30.5% year over year in the fourth quarter, up from 25.8% year-over-year growth in the third quarter. It is worth noting that as the earnings season began, year-over-year growth was expected to come in at just 19.8%.

What is true of the whole, must be true for at least most of the component parts. For the full year, earnings soared 44.7% for the S&P 500 as a whole in 2010. Then again, 2009 was not exactly a normal year, so it was working off some very easy comps. Growth is expected to slow to 14.9% in 2011, and then continue to fall to 13.4% in 2012 as the comparisons become more and more difficult.

Still, even the 2012 growth is pretty healthy. Revenue growth has been much slower and the market as a whole has been enjoying margin expansion, as have most of the sectors. Revenues grew 8.16% in 2010 and expected to grow 2.75% in 2011 and then accelerate to 6.16% growth in 2012. The revenue picture (and thus the net margin picture) is significantly distorted by the Financial sector, but the distortion should fade a bit over time.

Excluding the Financials, revenues grew by 9.64% in 2010, and are expected to slow to 6.53% growth in 2011 and 6.30% growth in 2012. Net margins for the whole S&P are expected to rise from 8.54% in 2010 to 9.55% in 2011, and continue rising to 10.20% in 2012. If one excludes the Financials, the margins are lower but still growing, rising to 8.78% in 2011 from 8.22% in 2010.

In 2012 the net margins excluding the Financials are expected to increase to 9.27%. The S&P 500 as a whole is selling for 16.0x 2010 earnings and 13.9x 2011 earnings expectations. If you are willing to look out to 2012 earnings the P/E ratio falls to 12.3x. The “per share” numbers work out to $83.31 for 2010 and $95.71 for 2011. In 2012, they are expected to pass the century mark for the first time ever, rising to $108.50.

S&P 500 ETF: (SPX)

Conglomerates (100% in)

This sector is a relatively small one, accounting for 3.48% of total expected earnings for 2011, but it does contain several household name stocks among its 10 members, including Dow components General Electric (GE), 3M (MMM) and United Technologies (UTX). It posted total net income that was 33.6% higher in the fourth quarter than a year ago. That is an acceleration from the 16.8% growth it posted in the third quarter.

For the full year, net income rose 11.2%, which is far below the growth rate of the S&P 500 as a whole. The sector is expected to continue to lag, growing just 8.0% in 2011, before accelerating to 17.7% growth in 2012.

On the top line, revenues grew just 1.06% in 2010. In 2011, revenues for the sector are expected to inch up just 0.4%, but accelerating to 5.67% in 2012. For all three years, that growth is well below that of the overall index, although the gap in 2012 is not all that big. For 2010, the anemic growth on the bottom line was still better than the rise on the top line. That can only mean rising margins, which rose to 8.97% for 2010 from 8.15% in 2009.

Further growth in net margins is expected, rising to 9.65% in 2011 and on to 10.75% by 2012. For both years that will put them above those of the market as a whole. The estimate revisions picture is very solid for these names, with 2.71 upward FY1 (mostly 2011) revisions for each cut, and 1.86 for each cut when it comes to FY2 (mostly 2012) estimates.

On the valuation front, the sector is a bit on the pricey side, at 17.2x 2010 earnings and 15.9x 2011 earnings. Looking out to 2012 earnings, it is selling for 13.5x. By its very nature, this sector is harder to make generalizations about than the other sectors. There are probably some good short-term trading opportunities in the sector, and despite the high valuations, some interesting longer term investments as well in the group.

However, you need to pick and choose carefully among the individual stocks. Although as a group I would categorize the sector as a turnaround story, and given the strong estimate momentum, one that appears to be working. I would market weight the sector and consider going to an overweight on a dip.


This is one of the biggest and most important of the sectors, expected to account for 17.65% of all earnings in 2011, up from 17.21% of all earnings in 2010. That will be second only to the Financials in terms of total earnings.

Growth in the fourth quarter slowed to 26.0% from a very strong 45.58% in the third quarter. For the full year, Tech was close to the top of the growth charts with earnings up 47.7% over 2009. That is particularly impressive, since unlike many of the other high growth sectors for 2010, earnings did not fall off a cliff in 2009. That year they were down just 5.0%.

Growth, though, is expected to slow to “just” 17.8% for 2011 and 12.0% for 2012. Hardly the end of the world for the sector. On the top line, growth was 15.31% for 2010 That is among the very best for the year and is all the more impressive since it is not just a function of higher commodity prices as was the case for the other two high revenue growth sectors for 2010, Energy and Materials.

Revenue growth is expected to slow to 10.21% for 2011 and to 8.24% in 2012, but in both cases that growth is comfortably above that of the index overall. The sector already boasts the highest net margins at 15.26% for 2010. They are expected to climb still further, reaching 16.31% in 2011 and 16.88% for 2012. That is far above the level of net margins for the index as a whole.

In terms of estimate momentum, the ratio of increases to cuts is positive for both years at 1.66 for FY1 and 1.30 for FY2, although on both counts they are lower than the index as a whole. Valuations are above the market as a whole, with the sector trading at 17.1x 2010 earnings and 14.5x 2011.

If you are willing to look out to the 2012 expected earnings, the sector is trading at 13.0x. This sector normally trades at a premium to the overall market, and the premium looks smaller than normal, so I am not that concerned about the somewhat higher-than-market P/Es for the sector. I would be inclined to overweight the sector modestly.

Technology SPDR ETF: (XLK)


This is a small sector, with only ten firms and expected to account for just 1.72% of overall S&P 500 profits in 2011, down from 1.92% in 2010. A very modest rebound in earnings share to 1.76% is expected for 2012.

Almost half of those earnings are expected to come from one firm, Boeing (BA). The rest of the sector is closely tied to the Pentagon (BA is, as well) and if the Congress is really serious about cutting overall spending, then Defense is going to have to be on the table. With two wars going on, the cuts will probably come more from hardware than from operations, which is bad news for the firms in this sector.

Quarter-to-quarter growth can be very lumpy in this sector. Year-over-year growth was a blistering 144.5% in the third quarter, but in the fourth quarter, earnings actually fell 2.9% below fourth quarter of 2009 levels. For the year as a whole, growth lagged the overall market badly in 2010, with earnings up 18.1% from 2009 levels. Things are not expected to get much better in 2011 either with total net income expected to rise just 2.6%.

The sector is expected to finally rise above the rest of the market in terms of income growth in 2012 with growth of 16.4%. As for the top line, the sector had the dubious distinction of being the only sector but Finance (and revenues for Financials are flakey by nature — more on that tomorrow) to actually post lower total revenues in 2010 than in 2009, although the decline was just 0.89%. Things are expected to pick up a bit in 2011 with growth of 4.30% expected, rising to 6.06% growth for 2012.

The sector is below average when it comes to net margins at 6.40% for 2010. They are expected to dip to 6.29% in 2011 then rebound to 6.91% in 2012. That will keep them still well below the market as a whole, and the sector shares the dubious distinction with Utilities, of being the only sector where net margins are expected to fall in 2011.

The revisions ratios are better than the index overall, with FY1 at 2.47 and FY2 at 3.22. I would caution though that for both years the sample is very small. While the overall fundamentals look worse than average for the sector, to some extent that has been priced into the market with lower than average P/E ratios.

The sector is trading for 13.5x 2010 and 12.1x 2011 earnings. Looking out to 2012 expectations it is selling for 11.3x. Still, there are probably better places to invest both short- and long-term, and I would underweight the sector.

Dow Jones US Aerospace & Defense ETF: (ITA)


This is one of the largest sectors, accounting for 12.35% of all S&P 500 earnings in 2010, rising to 12.89% for 2011. Driven by higher oil prices, earnings growth has been solid, with total net income up 40.5% in the fourth quarter over a year ago, up from 33.9% year-over-year growth in the third quarter. That growth is expected to cool to 19.8% in the first quarter, but that is still pretty good.

For the full year, the sector posted total net income that was 50.0% above 2009 levels, with growth of 19.9% and 14.8% expected for 2011 and 2012, respectively. The actual level of earnings going forward will depend a great deal on the price of oil, but it is worth noting that the expected total net income for the sector in 2012 is expected to be 35.4% above 2008 levels, when oil prices touched $148 a barrel.

Revenues rose 23.04% in 2010, the fastest revenue growth of any sector, slowing to a still-chart-topping 13.94% growth in 2011 and 8.88% in 2012. If the current oil prices hold, expect that both revenue and earnings growth to be much better than the current forecasts indicate. I have been moderately bullish on oil prices for 2011, looking for a year-end price of about $105 a barrel. However, with the rapid rise in recent weeks due to Mid-East turmoil, such a forecast is now moderately bearish.

Net margins for the sector are moderately below average at 7.64% for 2010, but are expected to climb to 8.04% for 2011 and 8.47% in 2012, still below average but closing the gap. On the estimate revisions front the sector is currently somewhat better than the index as a whole for both years, at 1.63 increases per cut for FY1 and 1.97 for FY2. However, given the recent rapid run-up in oil prices, I would expect more estimate increases in the near future.

The sector trades roughly in line with the market at 16.3x 2010 earnings and just 13.6x 2011 earnings. Looking ahead to 2012, it trades for 11.8x. Of course if estimates rise, the P/E ratios will fall. So what is not to like about the sector? Higher-than-average growth, growing net margins, good estimate momentum and valuations that are below the overall market based on 2011 and 2012 earnings estimates that are probably too low.

However, the stocks could pull back a bit if peace and normalcy were to break out in the Middle East. While I don’t have a better crystal ball than anyone else on the turmoil there, I doubt things will be resolved anytime soon. From a long-term strategic point of view, large oil reserves are getting harder and harder to find (and being located in more and more challenging environments, both natural and political).

Meanwhile, demand continues to grow — particularly in China and India, as well as domestically in the oil producing countries themselves. The more challenging physical environments do mean that it will be more expensive to extract the oil, but that is good news for the oil service firms. Rising prices over time means that those that hold significant reserves in the ground will be rewarded. I would overweight this sector significantly.

Energy SPDR ETF: (XLE)

This is the third in a series of four posts detailing the outlooks for each of the 16 Zacks economic sectors in the S&P 500. For the previous two posts see: “Cosumer, Retail and Medical Sector Overview” and “Sector Watch: Cyclicals“).

I plan to finish up tomorrow with an analysis of the Financial, Utilities, Transportation and Business Services sectors. You can find the underlying numbers in the Earnings Trends report (see insert link to current earnings trends when posted) to see how the sectors line up on each of the metrics discussed in this analysis as well as several others.

BOEING (BA): Free Stock Analysis Report

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About Dirk van Dijk 112 Articles

Affiliation: Zacks Investment Research

Dirk van Dijk, CFA is the Chief Equity Strategist for With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

Visit: Zacks Investment Research

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