Fourth-quarter 2016 earnings largely positive for large-cap growth companies
Investments in R&D lay the groundwork for potential future growth
As fourth-quarter earnings season winds down, it appears that US large-cap companies are on solid footing. Average year-over-year earnings for the S&P 500 Index grew two consecutive quarters to close out 2016 — the first time that has happened in more than two years.1
Large-cap growth companies fared especially well during the fourth quarter, with the Nasdaq-100 Index recording its third consecutive quarter of year-over-year earnings growth. Both the Nasdaq-100 Index and the S&P 500 Index exceeded Wall Street earnings expectations in the fourth quarter — beating average consensus estimates by 7.1% and 2.6%, respectively.1
So far in 2017, strong earnings have fueled large-company returns, although performance has varied. Through March 10, the Nasdaq-100 Index outperformed the S&P 500 Index by 4.6%.1 In my view, this differential is due in large part to the strong fourth-quarter earnings recently reported. But the Nasdaq-100’s strong performance has not been a short-term phenomenon. Since 2009, bellwether growth firms have helped the index outperform the broad-market S&P 500 Index in seven of eight years.1 Going forward, I expect this trend to continue, given that many of the largest growth names are investing heavily in research and development that could provide additional sources of future revenue.
Future cash flows key to equity valuations
One key driver of equity prices is the future value of cash flows. It’s up to corporate managers to decide whether to maximize cash flows in the short term at the expense of future cash flows, or vice versa. Long-term projects can take years before their benefits are fully realized, and pressure to beat last quarter’s results can too often lead to a reliance on short-term financial engineering. Moreover, long-term investments typically act as a drag on earnings during the years in which they are made, providing another disincentive to invest for the long haul. For companies with a long-term focus, however, these long-term investments may result in more sustainable revenue streams.
One advantage of the Nasdaq-100 Index is its exposure to research-oriented companies that tend to invest heavily in research and development. Based on partial fourth-quarter earnings results, Nasdaq-100 constituent companies invested 8.9% of revenues into research and development on average, versus an average of 4.3% for S&P 500 constituents — consistent with longer-term trends.1 Some notable examples include Microsoft’s strategic shift into cloud-based computing, Facebook’s focus on video and Alphabet’s development efforts in the field of artificial intelligence. (Alphabet is the parent company of Google.)
Cash repatriation could free up additional resources to fund growth
Much has been made of cash repatriation in recent months. With the Trump administration pushing to incentivize cash repatriation via tax code changes, technology companies could stand to benefit. As of Dec. 31, 2016, total cash and marketable securities for nonfinancial S&P 500 companies stood at $2.0 trillion, while 2016 aggregate free cash flow was $794 billion.1 Technology firms as a whole accounted for approximately half of these cash holdings and over a third of free cash flow.1
Much of these cash reserves are held overseas. For example, Apple reported that $230 billion of its $246 billion in cash and marketable securities was held abroad, which makes Apple one of the largest holders of foreign cash among US-based companies.2 Cash repatriation could benefit companies with large amounts of overseas cash holdings by providing ancillary investment and acquisition opportunities.
Investors seeking access to some of the most powerful companies in technology today may wish to consider PowerShares QQQ, an exchanged-traded fund that tracks the Nasdaq-100 Index.
QQQ’s allocations as of Dec. 31, 2016 — Apple: 10.9%, Microsoft: 8.6%, Facebook: 4.8%, Alphabet: 4.7%. Holdings mentioned for educational purposes only and are not buy or sell recommendations.
1 Source: Bloomberg L.P., as of March 10, 2017
2 Source: Apple, as of Jan. 31, 2017
Blog header image: Lucky-photographer/Shutterstock.com
Free cash flow is a measure of financial performance calculated as operating cash flow minus capital expenditures.
The Nasdaq-100 Index is a stock market index made up of 107 equity securities issued by 100 of the largest nonfinancial companies listed on the Nasdaq.
The S&P 500 Index is an unmanaged index considered representative of the US stock market.
Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.
There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The fund’s return may not match the return of the underlying index. The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the fund.
John Q. Frank, CFA
QQQ Equity Product Strategist
PowerShares by Invesco
John Frank is the QQQ Equity Product Strategist representing the PowerShares family of exchange-traded funds (ETFs). In this role, Mr. Frank works on researching, developing product-specific strategies and creating thought leadership to position and promote the PowerShares QQQ.
Prior to joining PowerShares, Mr. Frank was an Assistant Portfolio Manager at RS Core Capital, a multi-asset class investment firm. In this role, his primary responsibilities included research, risk management and asset allocation with a focus on the equity and hedge portfolios. Before RS Core Capital, he spent six years at J.P. Morgan Asset Management advising institutional investors on asset/liability management, asset allocation and pension regulation and worked across the defined benefit, defined contribution, endowment and foundation segments. He began his career at General Electric in a leadership development program where he was placed within the GE Energy division.
Mr. Frank earned a BSE degree in industrial & operations engineering from the University of Michigan – Ann Arbor and an MBA with Honors from the University of Chicago Booth School of Business with concentrations in analytic finance, econometrics, and statistics. He is a CFA charterholder and a member of the CFA Society of Chicago as well as the Beta Gamma Sigma Society.