Let me start this post by saying it is difficult for me not to focus on the incredible – and nearly daily – increase in the price of Tesla shares, which completely baffles me from a fundamental perspective. But having gotten this one wrong because I didn’t look at the underlying technicals of the shares (lesson to self: always look at short interest % float), I thought that it would be a worthwhile distraction to take a look at the performance of some real technology stocks. In this respect, there’s no place better to start than the infamous FAANG stocks (plus Microsoft, or “FAANG+M”). All of these tech giants have now reported their operating results for the most recent quarter, which can be summarised as follows: i) Google (Alphabet) and Facebook disappointed, ii) Netflix and Apple were neutral to slightly positive, and iii) Amazon and Microsoft impressed. But does one quarter really matter in the long run? Not if you’re a long-term “buy & hold” investor, a point that I am going to discuss in this post. I am not going to look at valuation, but rather three other specific things regarding the FAANG+M stocks:
1. What are the attributes of the FAANG+M stocks?
2. How have the FAANG and FAANG+M stocks performed over time compared to the S&P 500 index? You probably know that the answer is “very well", but - how much better?
3. How important are the FAANG and FAANG+M stocks to the S&P 500, and how has their relative importance changed over time?
This table shows some of the attributes of the FAANG+M stocks, so you can get a feel of their size and profile.
As the table indicates, three (and almost four) of the FAANG+M companies have market caps (equity only) of $1 trillion or more, and that is BIG. Two (FB and GOOGL) have no debt outstanding, three others are strong investment grade rated (including MSFT with rare Aaa/AAA ratings), and only one – NFLX – is non-investment grade rated. NFLX stands out for two other reasons too. Firstly, it is the smallest of the six companies by far, at more or less one-quarter the size of the next smallest one, FB. And secondly – and let this be a lesson to those shorting Tesla – it is the most shorted of the six stocks, with 4.67% of its float held short. As we are seeing in the case of Tesla, short covering can cause a stock to go significantly above its intrinsic value quickly, although admittedly the short interest in NFLX is much smaller than that of TSLA (at 18.6%).
With that background, let’s see how these companies have performed relative to one another and relative to the S&P 500 index over time. The graph below shows the relative performance of the FAANG+M stocks starting mid-May 2012, around the time that Facebook listed its shares, thereby becoming the last of these six tech names to become a public company. The prices used in this graph are weekly closing prices downloaded from Yahoo Finance. (Caveat: Facebook data is also weekly but the day doesn’t match the others for some reason – it is 2-3 days different which matters little for purpose of this analysis.) All are shown at a starting level of 100, so it is a relative performance illustration.
What is obviously most noteworthy is that - in spite of my comments about NFLX being the smallest of the six - it has by far been the best performer. To give you a flavour, NFLX has increased 33x its original price in a little under 8 years, whilst AMZN – the second best performer – has increased a bit over 9x its original price, still not a bad performance to say the least! The other four have all increased between 4x and 6x, still notably better than the S&P500 index, which has increased around 2.5x over the same period. Of course, each stock has had growth spurts and difficult periods. For example, you can see the difficulties that Facebook in particular encountered when the company was "front page news" as it was dealing with regulatory blowback in 2018, and you can see the uncertainty that crept into Netflix stock during the 3Q2019 due to competitive and other pressures. The graph below is the same one without NFLX, so you can better see the trends of the other five other stocks compared again to the S&P 500.
Another way to consider the returns is too look at the relative performance of a hypothetical market-weighted portfolio of the FAANG+M stocks compared to the S&P 500 over time. Let’s take a look, noting that I have used the year-end closing price of the FAANG+M shares and the year-end closing level of the S&P 500 for the 10-year period 2010-2019.
As the graph above illustrates, a market-weighted hypothetical portfolio of FAANG+M stocks over this period would have returned 7.3x your original investment, a CAGR of 22% (ignoring dividends). The S&P 500 would have given you back 2.4x your original investment, or a CAGR of 9.2% (also ignoring dividends). The return over this period in the S&P 500 index is excellent based on historical norms, but it comes nowhere close to the return over the same period of a hypothetical portfolio of FAANG+M stocks
Lastly - as is often reported - the FAANG stocks (and FAANG+M) have become increasingly influential in the S&P 500 index. The table to the left illustrates this (amounts are in $mms) . As you can see, the relative percentage of the FAANG+M stocks has become over three times more relevant in the index in the last 10 years, increasing from 6% of the S&P 500 at the end of 2009 to around 20% at the end of 2019. Very clearly, the performance of the FAANG+M stocks are a key driver of the S&P 500 index on any given day.
It is impossible to say what the future holds, as this entire analysis of the FAANG+M stocks has occurred through an unprecedented one-way upward trend in the market. Who knows really - if things should soften, these might be the very companies whose shares lead a downturn. However, I believe that most of the drivers of these stocks have been secular, not cyclical, as in almost every case, these companies have generated quarter after quarter of increasing revenues and net income. These companies have also shown that they can become defensive rather quickly. With the exception of one (NFLX), all are net cash positive; some have no debt at all and substantial amounts of cash on their balance sheets. (NFLX, which is non-IG rated, is the exception and will be borrowing in the future to support its growth in the coming years.) If growth were to slow, there would be a strong argument for most of these cash rich companies to return profits more aggressively to shareholders, either through dividends (only two pay dividends now, AAPL and MSFT) or share repurchases. All of these tech giants, with the exception of FB (not public until 2012) and NFLX (a different business until around 2012) have navigated through choppy waters, enduring several economic downturns. Each has had periods in which, for one reason or another, management had to reformulate a strategy and recreate the company, demonstrating a combination of foresight and incredible vision. Over time, these companies have demonstrated that they are truly market-leading companies that excel in their given business. Yes, as you can tell, I am a believer!
Disclaimer: I have owned all of the stocks mentioned in this post, but do not currently own NFLX or TSLA.
Commentaires