Are Financial Reports An Indicator Of An Upturn?

01/18/02

The end of January is always full of financial reports from public companies about how they did in the last quarter.  (For some, of course, this is also the last quarter of their fiscal year, and time to add up year-end results.) 

This year, financial reports are awaited with more than the usual eager anticipation, because the economists have informed us that we are in a recession, but that they believe it will be short, with a recovery beginning in the second or third quarter.  Everyone is reading the financial report tea leaves, looking for positive signs.

We Encourage Putting The Best Face On Things

To get to the tea leaves, you must drink a lot of tea.  Company executives, while sticking to the SEC rules about what they may safely say, always try to put the best face on things.  This leads to small positive differences being exaggerated and small negative ones being (nearly) shrugged off.  Interesting ways to carve up world markets and segment product categories are discovered, all in the service of convincing the financial press (and investors) that

Because we encourage Executives to put the best face on things (by the way we buy and sell the stock of their companies as well as our confidence in their products and services), we end up having to untangle the real status of the company’s finances from the true but often misleading statements we are perceived as demanding.

Mixed Results

When everything’s going in the same direction – especially up – there’s very little to explain.  A rising market and solid sales and revenues can cover a multitude of sins.

In the past year, when things have been much tougher, companies have had to prove their management mettle.  Some have risen mightily to the occasion.  Others have had too many past sins to rise above and are still in correction mode.

It makes it very hard to look at the mixed results we’re seeing now and to use them as the basis for the predictions we’d like to make.  Everyone would like to pinpoint:

	An end to the current recession – and soon.
	A strong recovery, rather than a slow, weak one (most economists say that’s unlikely to be in the cards).
	When IT buying will come off the critical list and resume the important role it’s played in not just the technology sector, but the economy.
	Which sectors will lead.
	Which technology companies will lead.
	When the IPO and Venture Capital windows will open again.

Clients often tell me the thing they dislike most about analysts and economists (oh, dear, I just realized I’m both!) is their habit of saying “On the one hand . . . on the other hand. . .”  But this is a very on the one hand – on the other hand kind of time.

IBM has increased its market share in important markets like software and larger servers (mainframes and Unix Regatta systems), but has had a tougher time in services (particularly outside the U.S.) and PC’s.  IBM still kept it’s earnings up, but revenues were a billion dollars below expectations for the quarter. Nevertheless, IBM fared better than many competitors since so much of its business is on a long-term contractual basis.  Also, IBM’s service backlog is up, currently at $102 Billion, so service sector expectations for the year are also good.  IBM has also increased its alliances with ISV’s to 184 (including 36 new this year in the over $10 million category), which bodes well for increased business.  See Wall Street Journal, January 18, 2002 and  http://www.investor.ibm.com/investor/4q01/4q01earnings.phtml.

Sun tried hard to make today’s announcement of continuing losses sound like good news – and it is, in the sense that losses are diminishing, sales increasing, and management control has tightened.  Sun has some very nice new high end software and new initiatives around its iPlanet software (which is now entirely Sun’s).  But Sun will have to find new customers to replace the dotcoms that brought it so much business in the past and continue to resist pressure from lower-cost Intel servers that continue to increase in popularity, especially in combination with other Unix operating systems like Linux.  See http://interactive.wsj.com/articles/SB1011360702152176040.htm and http://www.sun.com/smi/Press/sunflash/2002-01/sunflash.20020118.1.html. 

Microsoft, on the other hand, showed an increase in sales and revenues, based largely on its large shipments of new products (Office XP, Windows XP, and the new x-Box gaming system).  Microsoft’s profits, however, were down, reflecting lower sales in the PC market as well as a charge taken for a potential court settlement.  Financial analysts are not pleased that much of Microsoft’s revenue in the quarter was consumer- rather than business-related, since such revenue is considered less durable. See http://interactive.wsj.com/articles/SB1010181063659093320.htm and http://www.microsoft.com/presspass/Press/2002/Jan02/01-17Q02-2earningspr.asp.

Is There A Prediction Here?

These are some of the biggest, best, and most important high tech firms in the world.  They are surviving the recession nicely (some more nicely than others) thanks to huge numbers of customers (some in industries that are largely recession-proof, see Letters to the Editor exchange below), good products, and strong management.

Nevertheless, they are seeing the downside of economic cycles, the remains of the dot.com bust, and the uncertainty following the events of 9/11.

We believe by the middle of 2002 things will be looking up.  We don’t think every firm in the high tech industry will be in GREAT shape, but we think most of them will be fine.  We doubt that we’ll ever go back to the days of irrational exuberance, when VC’s would invest in anything, any time – but that’s probably a good idea.  A little common sense in evaluating high tech ideas is probably a good thing.

We might even see a few IPO’s.

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