In this car crash of a stock market, it may well be worthwhile to focus on the companies that will largely endure whatever investors throw at them.
Indeed, companies that significantly outperform the overall market.
So let’s look at the “FANGs.”
It was CNBC madman-in-chief Jim Cramer who coined the term when referring to a hyper-growth quartet of tech stocks…
- Facebook Inc (O:FB)
- Amazon.com Inc (O:AMZN)
- Netflix Inc (O:NFLX)
- Google Inc (O:GOOGL) – now called Alphabet Inc., of course.
Last year would’ve been a great time to own their shares…
- Facebook rose by 34.1%.
- Amazon surged by 117.7%.
- Netflix rocketed 129.5% higher, factoring in a 7:1 stock split on July 15, 2015.
- Alphabet jumped by 44.1%.
Compare that to the overall NASDAQ exchange, which only returned 5.7%, while the Dow Jones Industrials shed 2.2% and the S&P 500 posted a marginal 0.7% loss.
With 2015 in the books – and 2016 off to the worst start in history – it’s worth taking a look at these bellwether tech outperformers. But with a warning…
Judging the FANGs – Should You Buy or Sell?
While many investors found it profitable last year to let the momentum carry them, regardless of valuations, momentum only carries you so far. Eventually, these companies need to deliver what they’ve promised… or at least justify the valuations they attained last year.
So let’s take a look at each FANG stock and assess the prospects for this year using three metrics – value, growth, and competition – and whether you should buy or sell.
Value: At 95 times its trailing earnings, Facebook is expensive. However, earnings are growing so the forward price-to-earnings (P/E) ratio is a slightly more reasonable 33. But the price/earnings-to-growth (PEG) ratio, which incorporates earnings growth relative to the share price, is still very high at 3.1.
Growth: Analysts are projecting earnings to grow at over 31% per year over the next five years. This is possible but difficult – the years of 70% earnings growth are behind Facebook. Why?
Because we’ve hit “Peak Facebook.” Just about everyone who’s going to have a Facebook account already has one and advertising is nearing saturation.
Competition: In the tech sector, forced adoption is critical. That is, the point at which a technology or product enters the mainstream and everyone has to have it. Well, Facebook had the right social network at the right time and drove forced adoption of its platform. It’s crushed all challengers and is the go-to place for people to keep in touch with family and friends.
Verdict: Sell. Facebook enjoyed a good 2015, but its valuation is too high to justify its growth, and the risk of disappointment for investors is too high.
Amazon
Value: Insane. That’s the only way to describe Amazon’s valuation at this point in its existence. The company’s P/E is over 800 and even its forward P/E is over 100. The PEG ratio is an unsustainable 13.7. But hang on… Amazon may have a trick or two up its sleeve.
Growth: Wall Street expects Amazon’s profit to surge by 60% per year. That’s from a relatively small base, given the company’s size. CEO Jeff Bezos has reinvested the company’s profits in new initiatives and not only is there a sense that those initiatives will succeed, but that Amazon can slow the pace of investment at any point and generate profit at will.
In a tough market, Amazon will have to prove that it can do just that in order to justify its current valuation.
Competition: You know the deal with Amazon – it sells just about anything and there’s no likely contender that can challenge the company’s massive online retail base. However, as traditional rivals improve their web presences, it could slow the pace of Amazon’s retail growth. Other business like streaming media and cloud computing are also highly competitive and changing rapidly. The end of Amazon’s sales tax exemption in most states has erased much of its price advantage, too.
Verdict: Buy. This is a classic value versus growth battle, but the company’s growth estimates, coupled with its dominant position, make it a “Buy.” Watch it carefully, though.
Netflix
Value: If you think Amazon’s valuation is high, Netflix has it beat. It’s the most expensive FANG, with shares trading at over 220 times trailing earnings, over 440 times projected earnings, and has a PEG of 17.4.
Growth: Netflix will have to exceed Wall Street’s earnings growth projection of 28% in order to justify its share price. Many parts of the company’s business are still unprofitable or just tipping into profitability, so it’s possible for Netflix to grow enough to meet that high bar, but it will be a real challenge. Especially given its competition…
Competition: In a word: high. In true disruptive tech style, Netflix stormed onto the streaming media scene with a model that was far better than other upstarts like Hulu. But that first-mover advantage has gone and everyone else now wants in, including many content producers.
Netflix will spend over $6 billion making and acquiring content this year – almost as much as it earned in revenue for all of 2015. That number will rise, too, as more bidders fight for a limited amount of quality programming.
Verdict: Sell. Netflix has become a victim of its own success. It discovered a massive pie with its streaming services, and while it’s still hugely popular, too many rivals now want a piece of that pie, too.
Google (Alphabet)
Value: Compared to the other FANGs, Google is practically a value stock, with a trailing P/E of 26, a forward P/E of only 20, and a PEG of 1.87.
Growth: Google is also the most mature of the FANGs – a fact reflected in its earnings estimates. Analysts only expect earnings growth of under 16% over the next five years. However, with the various “moon shot” initiatives at parent company Alphabet, it’s the most likely to exceed estimates.
A comparison with Microsoft Corp (O:MSFT) is applicable here. The only times Microsoft earned a P/E above 50 were during its earliest growth stages in the mid-1980s and the dot-com bubble of 1998-2000. But adoption of new products is much faster today than it was when Microsoft was the king of growth, so believing in faster near-term earnings growth may be justified here.
Competition: While Google’s bread-and-butter advertising business faces some threats, the company has its hands in so many parts of internet advertising, it should profit even from competitors’ moves. Like Amazon, its other businesses are more vulnerable.
Verdict: Buy. Google isn’t going anywhere. Indeed, my colleague Louis Basenese believes the company is the No. 1 contender to buy Twitter (N:TWTR) Inc. (TWTR) this year – a move that would merely catapult its existing social media dominance into another universe. And with its driverless car venture and other research projects in the works, this company could have some surprises in store.
And Then There’s the Market…
I believe Amazon and Google have the best chance of exceeding their earnings expectations and that Google has the best chance of justifying its current valuation.
Facebook may provide the steadiest growth, while Netflix faces big challenges to merit its huge price.
Of course, the elephant in the room here is the overall stock market climate – which, as we all know, is pretty horrific at the moment.
The mood will no doubt settle at some point – such volatility doesn’t last forever. And if the market turns bullish again, it should bode well for the FANG stocks and their prices might stay high for some time.
But if the market turns into a long-term bear or these companies start missing their earnings, you don’t need to be Einstein to know that their stocks will be in trouble.