If you’re going to buy FANG stocks today, these are the three to focus on
The FANG group of tech stocks have fallen out of favour. But investors shouldn't write them off completely, says Rupert Hargreaves. Here are three that are still worth buying.
At the end of 2020, management consultancy McKinsey noted that digital adoption in the pandemic took a “quantum leap” forward as businesses and consumers had no choice but to work, shop and play online.
Nowhere was this trend more apparent than in the performance of the market’s top tech stocks, the so-called FANGs.
The FANGs were some of the best investments during the pandemic
The FANG group of tech companies, Meta (Nasdaq:FB) (formerly known as Facebook), Amazon (Nasdaq:AMZN), Netflix (Nasdaq:NFLX) and Alphabet (Nasdaq:GOOG) (the parent company of Google) collectively reported revenues of $532bn in 2019.
By the end of 2020, revenues across the group had jumped by 28% to $680bn. And by the end of 2021 that figure was $876bn, up 29% year-on-year and 64% since 2019.
Investors celebrated. The NYSE FANG+ Index, which provides exposure to the FANGs as well as Microsoft (MSFT), Apple (AAPL), Baidu (BIDU), Nvidia (NVDA), Alibaba (BABA) and Tesla (TSLA) doubled in 2020 and rose a further 22% in 2021.
But these companies are now falling out of favour with investors. Since the start of this year, the FANG+ Index has slumped by 24%, erasing all of 2021’s gains and then some.
Meta and Netflix specifically have lost 34% and 56% respectively over the past 12 months, which means they’re now underperforming the market over a five-year period – the Nasdaq has returned 128% over the past five years compared to Netflix’s 58% and Meta’s 40%.
Investors lose faith as challenges mount
Analysts are not short of reasons as to why the market has fallen out of love with these businesses. They point to rising interest rates, disruption, slowing growth and a rotation away from growth to value stocks.
But I think there’s a much simpler explanation: the market was just too overexcited about their prospects.
Netflix is a great example. At the end of November last year, the stock was trading at an all-time high of $690 per share or 61.6 times projected earnings for 2022.
Investors were happy to pay such a high price even although the company’s outlook was becoming increasingly uncertain as competitors such as Disney (NYSE: DIS) ploughed billions of dollars into their own streaming services.
Consumers can only watch so many hours of content a day, but despite this fact, the market seemed to think Netflix’s sales would continue to expand exponentially.
Meta’s performance also seems to have been a side-effect of investor overexcitement. In September last year, the company traded up to a price/earnings ratio of 28. That’s not too pricey for a growing tech business, but threats to growth were already emerging last year.
The problem is simple – Netflix and Facebook have lost their competitive edge
However, not all FANGs are created equal. Meta and Netflix’s problems are a result of an age-old problem in business: competition. Both have lost their competitive edge, and their slowdowns reflect this shift.
The other two components of the FANG complex, Amazon and Alphabet, have not lost theirs. Google remains the world’s go-to search engine, and the company’s cloud business serves millions of customers around the world.
Meanwhile, Amazon has built a global logistics giant, investing hundreds of billions of dollars over the past three years alone to develop its edge (it also has a highly profitable cloud division). Fellow FANG+ members Microsoft and Apple exhibit similar qualities.
Apple isn’t the world’s largest smartphone manufacturer, (that crown belongs to Samsung) but the company’s brand is one of the most valuable in the world, and consumers are willing to pay more to be part of the Apple ecosystem. As an Apple user I can also say that changing to another provider is almost more bother than it is worth. Apple makes the process of upgrading to its newest product as seamless as possible.
Yet despite their apparent competitive advantages, investors cannot take these businesses for granted. No company is immune from competition, no matter how big they are or how much cash they have at their disposal.
The companies with the best qualities to ride out uncertainty
While investors might be tempted to pick up some shares in Netflix, Meta or other FANG+ stocks after recent declines, I think the sector should be approached with caution. The tech market is only becoming ever more competitive, and businesses that are unable to maintain their competitive edges are going to be left behind.
Amazon stands out because the company has a culture of innovation and development. It would take huge sums of money for a competitor to try and edge in on its turf, especially in retail, where profit margins are razor thin.
Meanwhile, Alphabet’s competitive edge may endure because its Google search engine has a vast trove of the most valuable resource of the 21st century: data. With more than two decades of user data in the system, the company has an unrivalled reserve of information to help it analyse and understand user queries. It took Amazon half a decade and billions of dollars to build a big enough dataset to power its Alexa system even with its virtually limitless financial resources.
The FANG+ bubble might have burst, but that does not mean that investors should write off these companies completely. Alphabet, Amazon and Apple are still at the top of their game. Unfortunately, this might not last forever, but as long as they keep reinvesting to fend off the competition, they could continue to grow.