FAANG+M: "Up, Up & Away"

I have written about the infamous FAANG+M stocks two times in the past on emorningcoffee.com – on February 5th (pre-pandemic) and May 19th (post-pandemic) Three months later, it is time for another update, since this small group of stocks has continued to appreciate at a staggering rate since my last update. For example, Apple, the largest of the FAANGs by market cap (circa $2.17 trillion), declared a 4-for-1 stock split on July 30th which – alongside solid earnings released the same day – propelled the stock to over $500/share in only 17 trading days, a gain of 32% as of the date of this article (August 26th).

As has been written about extensively in the financial press, the influence of these six stocks as far as the performance of the S&P 500 is very material. In fact, the sheer size and dominance of several of these companies have raised antitrust (monopoly) and anticompetitive claims in several countries around the world, most recently in the U.S.. The CEO’s of Apple, Amazon, Facebook and Google were (virtually) brought before the House judiciary’s antitrust committee on July 29th to address a series of questions regarding mainly anticompetitive behaviour. You can read more about these proceedings in the BBC, and The Daily had an excellent summary podcast (“The Big Tech Hearings”, 33 mins) on the hearings which you can find here. At the moment, nothing has come of this and it feels very much like yesterday’s news, although these sorts of concerns will undoubtedly continue to dog these tech giants.

So how important are the FAANG+M tech companies? The graph below shows the relevancy of the stocks of these six companies collectively on a market-weighted basis compared to S&P 500 index since 2009.

The market-weighted value of the FAANG+M stocks collectively is currently $7.8 trillion, representing 27% of the total $28.8 trillion market capitalisation of the S&P 500 as of August 26th (source of S&P 500 data is Y-charts, adjusted for August). Even more amazing is the fact that the percentage of the index represented by this very influential group of stocks has increased to this level (27%) from only 19% at the end of 2019 as the pandemic has unexpectedly given them even more of a boost this year.

As you might surmise based on their growing relevancy in the index, the returns of these six stocks have been significantly better than most other stocks in the index. In fact, the dichotomy of performance as far as returns for 2020 YtD is hard to grasp. Whilst the FAANG+M stocks have returned 51.9% YtD, the remaining group of stocks in the index ­– the “S&P 494” – has collectively turned in a loss of 3.1%. (Fortunately for index investors, the weighting of the FAANG+M stocks is sufficiently influential to have pushed the index to a 7.5% gain YtD as of August 26th.) The skewed returns show that the current stock market recovery in the U.S. is far from balanced, perhaps not surprising given the poor shape of the U.S. economy caused by CV19. The table below shows similar returns for the FAANG+Ms, the S&P 500 and the “S&P 494” for the last 10 years and since the beginning of 2018, 2019 and 2020 (YtD).

Whilst the FAANG+M stocks have had an average annual return of 33.6% since the beginning of 2018 (2.65 years), the rest of the index collectively has barely had a positive return, averaging a return of only 1.2%/annum over the same period. In fact, until earlier this week, the return on the “S&P 494” had been negative overt his period!

This does not mean that the FAANG+M stocks don’t deserve their gains. Afterall, these companies are not Tesla with its ridiculous valuation, although they are richly valued at the moment by historical standards using even rudimentary valuation calculations like P/Es. These are large global companies with recognisable brands, top-drawer management teams and dominant market positions. All have extensive track records of impressive quarter-over-quarter growth in revenues, customers, earnings, cash flow generation, etc. As I mentioned the last time I wrote about the FAANG+M companies, all of these companies are also highly rated (or implied) with significant liquidity on hand (with the exception of NFLX).

In addition, it is important to understand that whilst the “S&P 494” has been a perennial underperformer vis-à-vis the FAANG+M stocks, many of its other components have also raced ahead in a similar fashion, performing very well since the pandemic. These include a host of “newer” technology companies and companies in some of the “recovery” subsectors like homebuilders. Some of the newer or less-followed technology companies in the S&P 500 that have also had impressive stock performance since pandemic lows include the likes of NVIDIA, AMD, Match.com, Adobe, Qualcomm, Paypal, Activision and Salesforce.com (amongst others). Here’s how these companies’ stocks have performed YtD and since the pandemic-lows in March, as well as their market capitalisation to give you a sense of their size.

Interestingly, if size were a criteria to join the infamous group of five FAANG stocks, four of the companies above – NVIDIA, Adobe, Paypal and Salesforce.com – all have market capitalisations above or close to that of Netflix, even after its 11.6% one-day gain yesterday!

Below is the updated profile for each of the six FAANG+M companies, which you might want to compare to similar tables that were in the previous emorningcoffee.com articles about the FAANG+M stocks.

You can see from a size perspective that the smallest FAANG+M is NFLX ($249 bln) and the largest is AAPL ($2.2 trillion). Four of the FAANG+M companies now have market caps in excess of $1 trillion. You might also want to compare the returns of the FAANG+M stocks to the ones mentioned in the table before, both YtD and since March lows. As you can see by comparing returns, you would have been better off holding some of the non-FAANG+M stocks in your portfolio in spite of the amazing performance of this well-followed group of mega-tech giants.

The chart below depicts the performance of each of the FAANG+M components on a relative basis since the beginning of the year, so you can see how these stocks have performed. The 7th line – the bottom one – is the S&P 500 index.

The influence of these stocks on ETF sectors is also an interesting topic, one I will cover in another post in the future. In the meantime, let me say something quickly about each of the FAANG+M companies recent performance.

Amazon (AMZN) was arguably the largest beneficiary of the government-imposed “stay at home” orders in many countries, as people had little choice but to significantly increase their on-line purchases. As an aside, the pandemic also accelerated the decline of “high street” retailers, a trend already underway. Especially vulnerable were those legacy retailers that have failed to proactively embrace an e-commerce component of their business and the “box stores” that were left nursing high fixed costs of infrastructure as revenues – and hence cash flows - dwindled to near-nothing. Once investors stopped fearing the worst in late March, Amazon became one of the first beneficiaries of the recovery favouring “stay at home” stocks. Closing at $1,626.61 on March 12th, AMZN began its recovery well before the market bottom on March 23rd, working its way back up from its lows and closing above $2,000 (again) on April 7th. It took less than three months for the stock to increase another 50%, closing above $3,000/share on July 6th, just after US Independence Day. For much of July and early August, AMZN traded in the $3,200-$3,300 context, but broke out in early August and is quickly heading towards $3,500/share (closed Aug 26th at $3,478.73/share). The company’s market capitalisation of equity has reached $1.7 trillion, putting it slightly ahead of MSFT as far as size. As far as results, AMZN delivered 2Q2020 numbers to back it’s ascent, which is not surprising given the globally strong position of this company. I will also remind readers before moving on that AMZN is more than an on-line retailer, with its strong cloud business, B2B offering, Amazon Prime (streaming) and so on.

Apple (AAPL) was a less clear beneficiary of the pandemic, at least initially, as it had to close most of its retail stores around the world. It was far from clear in the early stages of the pandemic whether or not on-line sales and other business segments of Apple (e.g. iTunes/Apple Music/TV, Apple Store, iCloud, Apple Pay, Apple Plus (streaming), etc.) would compensate for the significant loss of retail “walk-in” business, especially since AAPL has such popular and frequented stores. AAPL behaved more like the market in general initially, finding its floor on the same day as the broader market on March 23rd, at $223.76/share. Since it remained unclear how AAPL would navigate through the pandemic, the stock did not breach $300/share again until May 7th, a level it had reached earlier in 2020 prior to the pandemic. The stock continued to increase rather methodically in the early part of the summer, as economies creaked back open in most parts of the world. The catalyst for the next leg up was Apple’s earnings, announced on July 30th, which were better-than-consensus expectations both in terms of revenue growth and bottom-line earnings. However, the cherry on the cake was undoubtedly the 4-for-1 stock split. To be fair, AAPL, has a history of splitting its stock (last time in June 2014, 7-for-1), but it was particularly interesting coming on the heels of a 5-for-1 stock split that was announced by TSLA. In both cases, the mathematics of stock splits was thrown out the window as the shares of both companies rocketed upwards. AAPL has since risen above $500/share, giving AAPL the largest equity market capitalisation of any listed company in the world - nearly $2.2 trillion. AAPL pays a dividend and has been repurchasing its shares (visible in Q-o-Q decline in shares outstanding on its balance sheet), with the repurchases likely occurring early in the sell-off as the shares were getting clobbered. AAPL has also been to the debt markets twice since May to take advantage of record-low yields, adding to its cash pile. Of all the FAANG+M, I like AAPL as a company the best but – at these levels – I like the stock the least of all the FAANG+M because I think it has gotten significantly ahead of itself with a P/E of 38.4x, too high for the company based on its historical median P/E (15.7x last 10 years), even with its solid growth and a forward P/E of 30.1x. It is worth keeping an eye on AAPL post-split to see how / if the stock settles at an equivalent (pre-split) price in the mid-$400’s.

Facebook (FB) and Google (GOOG, sub of Alphabet) both have a meaningful amount of their revenues tied to advertising, and therefore, I always felt they were potentially the most vulnerable during the pandemic as their customers cut back their spending. FB and GOOG also faced blowback from some global companies in June that began pulling their advertising business from FB, GOOG, Twitter and others, because these social media giants were thought to be not sufficiently aggressive in reigning in inflammatory and misleading posts. Nonetheless, this concern eventually faded, at least for the time being, with little effect on the share prices of either FB or GOOG. As far as their trajectory, FB and GOOG hit lows on March 16th, of $146.01/share and $1,084.33/share, respectively. However, both have recovered nicely since then, with FB up a whopping 82.9% and GOOG up 49.6% since their March lows. FB had better-than-expected 2Q20 results, which gave its shares another boost even as revenue and earnings growth moderated. Still, one has to keep in mind that FB has 2.5 bln customers across its various platforms, nearly 1/3 of the global population! GOOG’s results were more mixed, beating expectations but having its first ever quarterly decline in revenues as the company suffered from an expected decline in advertising revenues. However, these concerns seemed to also fade as the stock managed to reclaim its record high late last week, returning to its pre-earnings announcement levels. Amongst this distinguished group of stocks, I felt FB and GOOG had the most potential as recovery plays from the pandemic early in May, which I pointed out in my prior post. However, these stocks have also come a long ways quickly and are arguably valued fairly now, Interestingly, GOOG has most recently joined the $1 trillion market-cap club, taking its place alongside AAPL, AMZN and MSFT. One last thing to note is that FB and GOOG are the only two members of the FAANG+M group that have had their short interests increase since my last article on this group of stocks.

Microsoft (MSFT) continues to be one of the strongest global technology companies across its broad array of businesses. I wrote about why MSFT should be a core holding in an investor’s portfolio back on April 2nd, and you can find that article here. Like AAPL, MSFT offers a modest dividend and is not shy about buying back its shares when the company believes that there is an opportunity to do so at attractive values. It also has circa 50% more cash on hand ($136.5 bln) than AAPL, and retains an impressive Aaa/AAA credit rating, as high of credit ratings possible. MSFT released its FY2020 results on July 22nd and had solid revenue growth for the 4Q (ended June 30th) although it missed expectations and earnings declined. The culprit seemed mainly to be the company’s retail stores, which – like AAPL – were closed through the early stages of the pandemic. In fact, just before releasing their earnings, MSFT announced that it would be closing all 83 of its retail stores globally, abandoning an “Apple-like” consumer-focused strategy as its turned its attention even more to its excellent B2B portfolio of businesses. MSFT is up 40.6% YtD and 57.3% off its March lows, with a P/E ratio that is the same now as AAPL (38.4x, 10-year median P/E of MSFT is 19.1x).

Netflix (NFLX) remains somewhat of an anomaly in that it is the smallest of the FAANG stocks and is also the only one that is significantly cash flow negative (although bottom-line positive). NFLX clearly benefitted during the lock-down as people watched more of the company’s programming (more”screen time”) and new subscribers came on board. The stock closed below $300/share on March 16th, its lowest close of the year, but was rallying already into the market lows on March 23rd. NFLX reached its highest close of the year before yesterday - $527.39 – on July 16th, just prior to announcing its earnings. The company had excellent results but provided a cautious outlook, which seemed to rattle investors. I have written about Netflix twice in the past, once on February 14th (focus on company) and again on April 17th (focus on valuation) and I set forth my concerns in these two articles although – to be fair – the stock has rallied considerably nonetheless, up 69.2% YtD through August 26th. In summary, my major concerns regarding NFLX revolve around two things: the fact that the company remains cash flow negative (due to cost of developing programming, which is ongoing); and the growing list of competitors entering the streaming market, most with deep catalogues of legacy content and long histories of developing new and popular programming. NFLX’s stock had settled in the $475-$500 range since mid-July, well of its early July highs, that is until yesterday when the stock broke out (an understatement!) closing up 11.6% at $547.53, just a touch away from its early July record high. Aside from AMZN and AAPL, NFLX has had the best performance YtD (+69.2%), thanks largely to its unexpected increase yesterday.

Conclusion

This elite group of stocks has been a key driver of the record-fast recovery off pandemic lows less than six months ago and are significant contributors to the S&P 500 reaching a new record yesterday (Aug 26th) of 3,478.73. I hope you have owned one or more of these infamous stocks. Their strong performance is certainly merited, but a closer examination of the S&P 500 reveals how staggeringly weak the rest of the index is in comparison. At some point, this could result in a rotation into more stable and / or value stocks, but this will only happen if the momentum from the FAANG+M stocks is eventually curtailed. Given the way the market is going at the moment, I’m just not sure I would bet on this being imminent.