Investors love to rally around a stock story. Today it’s all about the FAANG stocks. Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Google (GOOG) are a major reason why the S&P 500 rallied so much in 2017. Mr. Market is convinced the FAANGs are impervious to a sell-off. “Its different this time” is ringing loud and clear, but will the outcome really be that different?
Let’s take a walk down memory lane. The Nifty-Fifty were a basket of 50 blue chip, stable growth companies that drove stocks higher during the late 1960’s and early 70’s. Enter 1973. With inflation skyrocketing, and Watergate and the Vietnam Conflict adding political and social disarray to the country, stocks plummeted. Some of the Nifty-Fifty fell 70-90% from their highs.
Fast forward to the Dot-com era of the late 90’s, which created one of the great asset bubbles in the history of the stock market. Future expectations of anything related to the internet were so far ahead of actual company fundamentals, that valuations based on “eye-balls” went through the roof. When the bubble burst, so too did many of the dotcoms.
In 2001, China joined the World Trade Organization, sparking a great run into commodity stocks. Investors stockpiled their portfolios into BRIC (Brazil, Russia, India and China) stocks and funds, chasing China’s never-ending growth. When the global economy came to a standstill in 2008, the BRICs came tumbling down.
Understanding the bull case for the FAANGs is easy. Arguing the bear case is not, especially when the trailing performance for these companies is so spectacular. Here are the Cliff notes (happy to discuss in more detail):
FB: Privacy issues are percolating. Russian tampering of the US elections through Facebook is a big red flag. Regulatory risk does not seem to be priced into the stock.
GOOG: Like FB, GOOG dominates the ad world, but competition from other social media sites, the use of Apps, and voice recognition (think Alexa), reduce the traditional way of thinking about the internet. GOOG has tremendous assets like YouTube, but advertisers are cautious given the content is not entirely filtered.
NFLX: NFLX is the most egregious of the group from a valuation standpoint. The company continues to grow subscribers globally, but its future growth relies on being able to create new content. Content is king in the media world, but it is very difficult to stay on top.
AMZN: Any other company with thin margins, little profitability, and a management team that discloses very little information, and the stock would be a perennial loser. Instead, investors cannot get enough of AMZN. The moment Amazon takes its foot off the gas pedal for reinvesting in its business and allows profits to fall to the bottom line is, ironically, when the valuation multiple will decline and with it the stock price.
AAPL: The next iPhone upgrade cycle has begun. However, all of the other FAANGs are going after Apple’s dominance. Amazon is pricing its hardware devices so low to destroy iPad and AppleTV. YouTube, Netflix and Amazon Prime TV are already established players in the content world and growing, a place Apple has been slow to embrace.
Investors should look to the unloved sectors. Try AT&T (T), Hanesbrands (HBI), and GlaxoSmithKline (GSK). All three are high quality companies that are in depressed industries right now. Telecom was the worst performing sector in the S&P 500 in 2017. Assuming T completes its merger with Time Warner (TWX), the combined entity will have created an end-to-end communications-media company controlling wireless, satellite (DTV), and content (HBO). At current prices AT&T offers investors a 5% dividend yield, so you get paid to wait.
The market hates retail right now. However, HBI is the #1 or #2 player in every category in which it competes. The stock is trading at a 50% discount to the market, but at current prices offers investors a 9% free cash flow yield.
Finally, healthcare stocks have sold off on renewed fears of regulating drug prices. GSK has three very strong franchises in HIV, vaccines, and consumer, which generate significant cash flow. They return that cash to shareholders in a big dividend, current yield of 5.8%. At current prices the company is worth more in parts than it is currently being valued as a whole.
Note: John J. Petrides, MBA, is a Managing Director and Portfolio Manager at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit. Certain clients of Point View own shares of all stocks mentioned. Mr. Petrides owns shares of Apple (AAPL), GlaxoSmithKline (GSK), and AT&T (T) personally.
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