Anyone who follows the stock market knows that ever since inflation started to ramp up six months ago Tech has been cratering. For the past decade the glamorous FAANG stocks have been the Rock Stars of the stock world, responsible for much the S&P 500’s (SPY) and the Invesco QQQ ETF’s (QQQ) impressive gains. But over the past six months they have seen dramatic losses that have dragged down both SPY and QQQ.
Understanding how they might behave in the future is essential not only for those who invest directly in these companies, but also for the many investors in QQQ and derivative indexes where the FAANGs, even after their recent price decline make up 40.78% of the entire value of the ETFs.
The FAANGs Have Been the Poster Kids for the Recent Tech Crash
Jim Cramer coined the acronym FAANG back in 2013 as shorthand for the hottest Tech stocks of the day. The term is just a catchy rearrangement of the first initial of Facebook (FB) – which was renamed Meta Platforms, Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Google (GOOGL) (GOOG), renamed Alphabet.
But oh, how the mighty have fallen! Alphabet’s price is fully in correction territory, down more than 21% over the past six month. Amazon has lost some 36% of its value since November. Meta Platforms has come down 42% over the same period. And Netflix, ouch! It’s fallen more than 72% over the past six months.
FAANG Stocks’ Dramatic Six Months of Losses
At first glance, Apple might seem to have escaped the contagion. Until you realize that it was down 19.72% on May 12, just narrowly escaping falling into correction territory.
So what’s the story? Do these steep declines represent a terrific buying opportunity for investors who missed the chance to get into these stocks years ago? Or are we looking at a cautionary tale of momentum investing hitting a brick wall, of ridiculous valuations reverting to the mean, and fickle investors leaving yesterday’s darlings behind as they move on to the Next Big Thing?
The FAANG Stocks Earned their Popularity By Racking Up Spectacular Growth in the 2010s
Back when Cramer gave these stocks their catchy name, they were in fact growing earnings at rates few stocks will every achieve.
For the year 2012, Facebook had grown its earnings by 66%. In The next year they grew 101%. Though Facebook’s P/E hovered in the lower 60s throughout the next six years, investors’ hopes were justified. Over the next five years, Facebook’s annual earnings growth fluctuated between a high of 86% and a low of a still impressive 23%.*
In one year, back in 2013, Amazon grew its earnings by a whopping 756%, though to put this into context, those earnings were only $0.59 per share for a stock that ended the year with a share price of $396. Investors who bought Amazon in 2013 ended up with a Ten Bagger, as its earnings have shot up by a phenomenal 10,985%, rising from $0.59 to $64.81.
Since 2013 Netflix’s earnings per share have grown by 4,323%, soaring from $0.26 in 2013 to a peak of $11.24 in 2021.
Facebook’s earnings grew by 778% since 2014 surging from $1.77 to a peak of $13.77 in 2021.
Since 2013 Google’s earnings have risen 505%, climbing from $22.22 to a peak of $112.20 in 2021.
Apple, which has been the stock with the largest market cap in the world until just a few weeks ago grew its earnings the most slowly of the five FAANGs, but it still has quadrupled those earnings since 2013, growing them by 395% from $1.42 to $5.61. Investors who bought any of these stocks back a decade ago when most looked to be carrying highly inflated multiples have done extremely well.
This has led a lot of pundits to proclaim that they are terrific values now. It is often pointed out that Apple’s P/E ratio of 26.40 is lower than that of slow growing, reliable dividend aristocrat Procter & Gamble (PG) whose P/E ratio is currently 26.40. In fact, all of the FAANGs except for Amazon currently have P/E ratios below that of Procter & Gamble.
The comparison with Procter & Gamble is telling, because it is a prime example of how overvalued dividend stocks have become during the era when retirees seeking to live off of the income generated by their portfolios were forced to buy risky stock dividends rather than safer bonds or CDs. Take a look at the Fastgraph displaying how Procter & Gamble’s P/E ratio has soared since the beginning of the Fed’s suppression of interest rates. (The Blue Line represents the average P/E over this period.)
Procter & Gamble Price, Earnings and Dividend History Since 2002
Are FAANG Stocks Overvalued Now?
Looking at their valuations through the lens of FastGraphs‘ Forecasting Calculator, the two FAANG stocks that have seen the worst price deterioration over the past three months do appear to be decently valued now. They are Meta Platforms and Netflix.
We’ll look at them and the rest of the FAANGs through the lens of the FastGraphs calculator that estimates a fair value price range for a stock based on applying the Graham Dodd formula to Analysts’ consensus forecasts of future earnings. (In these graphs, the thick orange line represents the calculated fair value for the stock going forward with a range plus or minus depicted by the lighter orange line.)
Meta Platforms (Facebook)
Meta Platforms (Facebook) Seems to Be at Fair Value
So yes, Meta Platforms does seem to be within the range of fair value. But that said, you can see that earnings are forecast to drop next year, recover slowly in 2023, and only grow at a much higher rate in 2024. But before you conclude that Meta is a great buy at its current price, you must keep in mind that the numbers for 2023 and 2024 are just forecasts. Long familiarity with Analysts’ consensus forecasts has taught me that these forecasts tend to grow far more optimistically the further away they are in time. It is only as an earnings report approaches that analysts revise them downwards. This makes the analysts look good, but it really harms investors who trust forecasts further out in time than a few months.
To emphasize that point, the bottom row of data on the FastGraphs Forecast Calculator graph shows how analysts’ estimates have changed over the past six months. It shows that analysts have been revising their estimates of Meta Platform’s earnings down every three months. There is no reason to believe that trend won’t continue.
Netflix Is Near Fair Value
Netflix appears to be very close to fair value now, too. Like Meta Platforms it is expected to see earnings decline this year and then recover in 2023 and 2024. But again, you have to take these forecasts with a grain of salt.
The bottom row on the graph which displays how analysts’ forecasts have changed over the past six months show that these forecasts have dropped by roughly 30% since six months ago, coming down every three months. This doesn’t encourage me to believe that we can trust that Netflix earnings will recover within that short time frame.
Amazon’s Valuation is, As Always, a Train Wreck
Any investor who decided not to buy Amazon until it looked well valued has never owned Amazon. They have also missed out on the obscene capital gains they could have earned had they bought it at any time before 2018. No matter how much Amazon’s sales have grown over the past 20 years, very little of those sales have made their way into reported earnings, as Amazon has always used most of its revenue to fund its growth as it has transformed from an online bookstore into a publisher, a grocery company, a package delivery company, a streaming service, a cloud service, a social media platform, and an advertising powerhouse.
But the Amazon of today may not be the same company as the Amazon that became the 10 bagger. The last year has seen a transfer of power from founder Jeff Bezos to Andy Jassy, leaving open the question of what Amazon’s future will look like. Yes, Amazon experienced a huge surge in business during the COVID-19 lockdowns when consumers were unable to shop anywhere but online, but Analysts are currently forecasting that it will take a few years for earnings to match what they were in 2021. Here again, we see that over the past six months the analysts’ forecast for 2023 and 2024 have also been dropping.
Google (Alphabet) is Still Highly Valued for Forecast Earnings Growth
Alphabet grew its earnings very steadily in the years between its IPO and 2019. Like the other FAANG stocks it saw a huge surge in sales due to the increase in online activity due to lockdowns. But those glory days are over now that most people have resumed their ordinary way of life. This has led to Alphabet now being on track to report earnings in December of 2022 that will represent the first decrease in earnings per share it has ever recorded.
Unlike the other stocks we have just looked at, analysts have been cautiously raising their estimates of Alphabet’s future earnings for 2022, 2023, and 2024 over the past three months. But even so, they are only estimating that Alphabet will grow at a relatively sedate rate of 11.29% over that three-year period.
Apple Is Highly Overvalued for Very Modest Future Earnings Growth
Apple is another of those stocks every investor wishes they had bought years ago. And it, too, has profited mightily from the COVID-19 lockdowns. But it now faces the fate of every company that has ever become the biggest in the world. When you have a $2.38 Trillion market cap, double digit growth gets harder and harder. Companies mature, and almost all of the hot #1 stocks of 30 or 40 years ago have now entered the ranks of the stodgy but dependable dividend-payers beloved by retirees. Investors a generation ago invested in Exxon Mobil (XOM), IBM (IBM), and GE as growth stocks, the way investors invest in Apple now.
And that is where the overvaluation really becomes an issue. Apple is only forecast to grow earnings over the next three years at a single digit rate of 7.69%, but it is still priced like a growth stock, with a P/E ratio of 24.83. Analysts have raised their earnings estimates for Apple over the past six months, but their increased optimism still only forecasts a three year growth rate well below 10%.
The FAANGs Have Matured And Are No Longer Growth Stocks
Apple’s forecast 7.69% earnings growth rate, points to the cloud hanging over the FAANGs. It will take a resurgence of extreme growth to justify the valuations that Apple, Amazon, and Alphabet currently trade at. That makes their stocks extremely vulnerable to a single disappointing earnings call.
The sharp corrections that Meta Platforms and Netflix experienced this past year show you just how swiftly those corrections can take place.
Disappointing Earnings and Weak Forward Guidance Crash Meta Platforms
Meta’s price dropped from $323/share to $277 in a single day, when the company reported fourth-quarter earnings that missed consensus forecasts and issued disappointing forward guidance.
Netflix Price Crashes After 1st Quarter Disturbing Forward Guidance
Netflix dropped from $348/share to $226 in a single day after reporting a decline in subscribers and the likelihood of that they would decline further.
A Single Disappointing Quarter or Worrisome Guidance Could Crash the Other FAANGs
That kind of extreme collapse is what happens when investors realize that no matter how profitable their company might be, it isn’t going to be growing earnings at a rate that justifies the lofty valuation they have assigned it. It is very possible that Apple, Alphabet, and Amazon could experience similar price collapses even when reporting earnings that aren’t all that far off from analysts’ projections, if their forward guidance suggests that they really are going to be growing earnings at an average rate of 10% or less.
One of These Stocks Is Not Like the Others
A case could be made that Netflix never really belonged in the same discussion as the other FAANGs as it is pretty much a one trick pony, and its streaming and media production business has no moat. They are competing for subscribers with the deep pockets of Amazon, Apple, Warner Bros. Discovery (WBD), Comcast (CMCSA) most of which have greater resources and run far more diversified businesses.
Even when Netflix was at its overvalued height back when I wrote about QQQ on September 14, 2021, Netflix’s market cap was only $265 Billion. That was dwarfed by Amazon’s $1.757 Trillion market cap at the time. Amazon is also, as we mentioned earlier, in the media production and streaming business. In fact, back in the fall of 2021, Apple, Alphabet, Amazon, and Facebook all had market caps over $1 Trillion, Apple, Alphabet, and Amazon still do.
So a good case could be made that those three stocks have far more in common with each other than any other no matter how catchy an acronym their first initials might make. Meta Platforms has been struggling to diversify like these other more established FAANGs but has not yet really pulled that off.
Diversifying Into A Small Number of Highly Profitable Other Businesses has Kept The 4 FAANGs’ Earnings Growing
This brings up the subject of the diversification of businesses within the overall company that has been going on within the FAANGs minus Netflix. It is essential to consider this internal diversification to understand their future performance.
Once upon a time, Google sold advertising, Amazon sold books and hard goods, Facebook provided sites where people could brag to friends and relatives, while Apple sold computers, software, and nifty gizmos for carrying around your favorite tunes.
But as these companies have grown to dominate the markets in the years after the Financial Crisis, they have had to find a way to diversify their businesses, using their profits to buy up or initiate entirely new profit streams.
As a result now, Alphabet still sells advertising, but it also sells hardware (Pixel phones, Nest etc.), books and other media, a payment service (Google Pay), and cloud services.
Amazon still sells books and hard goods, but it also sells hardware – tablets and Alexa devices, its Prime streaming service, social media (Twitch), groceries, pharmaceuticals, and is increasingly making more from selling advertising to its merchants than it does from providing them a marketplace where they can sell. It is pioneering a payment system to be used outside of Amazon.
Apple still mostly sells hardware and tunes, but it is also expanding its streaming business, wearables, cloud services, (iCloud), and payment processing businesses (Apple Pay).
Facebook has attempted to branch out into other businesses besides its social media sites. It does have a foothold in the Virtual Reality market with the Oculus. But its management knows that to get back into the Trillion dollar club Meta Platforms needs to diversify away from its controversial Social Media sites. It’s current price decline owes a lot to Apple’s latest operating system blocking the trackers essential to its ad business, hence the recent name change.
Meta Platforms social media sites are still its predominant business. It has experimented with getting users to use its social media sites as marketplaces, payment systems, and streaming platforms. It has also tried to market a hardware “portal,” targeting older consumers, though none of these endeavors has made much of a contribution to its earnings.
But you should see a pattern here. All these mega cap companies are competing with each other for the most profitable businesses: Advertising, Marketplaces, Hardware, Streaming, and Payment systems.
There is a limit to the size of those very profitable tech-related businesses. With the Trillionaires all competing with each other in those same niches, eventually if they are to continue to grow their earnings, they will have to expand into yet other profitable businesses where the big players are still currently owned by smaller companies. Amazon’s expansion into pharmaceuticals, and grocery delivery is a good example. We may end up seeing iFunerals, Prime orthodontia, and Google Homes if all of these super rich, super powerful companies continue to expand this way.
Where are the FAANG Stocks Headed?
Market History teaches us the perils that await companies that embrace diversification as the pathway to continued aggressive earnings growth.
Are the Mega Cap FAANGs Going to Be Like Microsoft or Like GE?
Microsoft (MSFT) stands alone among all mega cap in its ability to reinvent itself decade after decade and stay at the top of the both the S&P 500 (SPY) and QQQ for more than 20 years. It has had its ups and downs, but though it failed to break into the mobile business, it has managed to expand from selling hardware and software successfully into being a major player in gaming and the Cloud. But it is important to note that as it has moved through time, it has not tried to run too many different kinds of businesses all at once.
Microsoft Has Managed to Stay on Top for Decades
Long-term investors in Microsoft who held it through its price collapse after the Dot.com boom have been magnificently rewarded. It is possible that the FAANGs minus Netflix might be able to follow in their footsteps, especially Apple, which like Microsoft has a long history of profitability even when out of favor with investors.
General Electric (GE) on the other hand fell from its position as one of the top stocks in the S&P 500 after diversifying too broadly. CEO Jack Welch acquired hundreds of companies, but GE couldn’t manage to pull them together into a coherent whole.
GE’s Decline During the Great Bull Market
Two Possible Paths Await the FAANGs: World Domination or Morphing into Mature, Dividend Paying Stocks
Market leaders of the past whose businesses reached the limits of possible expansion like IBM (IBM), Walmart (WMT), and McDonald’s (MCD), that did not find a way to diversify into other businesses offering new growth prospects, have turned into the dividend payers retirees invest in. This is the fate of many mature businesses. They are highly profitable, highly reliable, but not able to grow earnings each year at the 30% or more rate that would make them growth stock super stars.
It is quite possible that the FAANGs minus Netflix might go in that direction. The other alternative might be that these companies are able to manage increasingly diverse operations that expand into whatever profitable business niches remain and have not yet been fully exploited by global mega cap companies. If they do this, they may be able to keep growing their earnings at aggressive growth rates again, after a few years of consolidation following the excess earnings attributable to the lockdowns.
Bottom Line: Choose Your Entry Point Based on Which Scenario You Believe Will Unfold
If you believe that these stocks can continue to diversify successfully and find new lines of business that allow for dramatically increasing earnings, buying them after this recent pullback makes sense.
But if you think they are more likely to follow the usual trajectory of successful growth companies and eventually mature into staid, dividend paying stocks whose companies make enormous profits that only grow earnings modestly year-to-year, it makes more sense to wait until their prices come down to a level that matches their currently very modest, dividend-stock-like projected annual earnings growth rates.
Apple is most likely to fall into this category. Unlike the other FAANGs, Apple currently does pay a small dividend – yielding 0.63% to be exact, though its yield has been far higher during the past five years. The only high quality dividend stocks that carry a P/E ratio as high as that of Apple right now are those that most value investors consider to be way overpriced for their earnings capacity.
The dividend aristocrats as a whole, as represented by ProShares S&P 500 Dividend Aristocrats ETF (NOBL), currently have a composite P/E ratio of 19.17 and an average dividend yield of 1.54%, which is more than twice that of Apple. A price that would raise Apple’s current dividend yield to a level near 1.54% would be around $39/share, which is where its price and dividend were as recently as September 2017. Its dividend yield was at 1.39% as recently as September of 2019, right before COVID-19 struck. Its price at that time was around $45/share.
None of the other FAANGs pay a dividend. Amazon is very unlikely to go this route given its history of aggressive expansion and a “who cares” attitude towards growing earnings. Alphabet and Meta Platforms certainly have the earnings to pay good dividends, but it is impossible to speculate on pricing since they have never shown any inclination to do so.
Price Targets Based on Valuation and Current Earnings Growth Rate Forecasts
Using the earnings estimates we saw in the FastGraphs above to make a first pass. If these stocks reach the prices listed below, it would be time to do a deeper dive into their financials and the current conditions of their profitable business lines.
For Apple, right now, that valuation based price looks like it might be around $100/share or less, based on current earnings forecasts. If it were to mature into a high quality dividend stock it could conceivably have a higher valuation, though not until its dividend rose to be competitive with other high quality dividend stocks.
For Alphabet that price looks like $1,832/share, based on current earnings estimates.
For Amazon that price looks like somewhere around $1,000/share assuming that earnings recover in 2023. But take that with a grain of salt.
As well-valued as Meta Platforms seems to be right now, it might have too many vulnerabilities to be in the same conversation as the “Three A’s.” It sounds like it is betting the farm on the Metaverse, which is a catchy phrase but as of yet, not much more than a concept. Its social media business model has been too polarizing, and its impact on society, especially the young people enticed by Instagram Influencers has been so damaging, that it is very likely that it will be encountering more roadblocks along the lines of Apple’s privacy move, some of it from international governing bodies.
* All earnings and P/E ratio data are as reported by FastGraphs between May 11 and May 13, 2022 when this article was written.