Stories about FANGs have bite
Tech-firm grouping makes little sense, but plays role in ‘value’ vs. growth stocks debate
Tales told about stocks have a powerful hold on investors, and no story is more powerful today than the FANGs—now widened to include an array of technology companies beyond the original Facebook, Amazon, Netflix and Google, now Alphabet.
The past two weeks have shown both why the wider FANGs grouping makes little sense, and at the same time how important it is to the bigger debate about whether to buy cheaper “value” stocks or pay up for expensive companies with better growth prospects.
Putting together a selection of big disruptive companies is a reasonable idea; it is growth investing in its purest form. But the original thought has been broadened to include anything big and vaguely techy: the widely referenced NYSE FANG+ index includes Tesla, Apple, NVidia and Twitter, as well as two large Chinese companies, while last month Goldman Sachs analysts included Microsoft to get the “FAAMG.” Needless to say, that acronym hasn’t caught on.
The approach mixes disruption (Amazon, Tesla, social media, Netflix, Alphabet); highmargin network semi-monopolies (Facebook, Alphabet, Microsoft); high-margin brands (Apple) and technological leadership (NVidia).
Yet, the moves in the FANG complex mattered, for two reasons. They have become synonymous with growth, so investors to some extent are happy to substitute one company for another, meaning moves in the price of one affect the price of the others. The FANGs-etc. are also huge: the FAAMGs are now the five biggest companies in the U.S..
As a result, the bad news from
Facebook and Twitter, showing that social-media companies face higher costs to police their users’ posts, rippled through the wider market—even though the same issues don’t apply to companies such as Amazon, Apple or Alphabet.
It wasn’t just that the FANGs-etc. fell. The market had its biggest three-day swing away from growth stocks and into cheaper “value” stocks since 2009. Almost 60% of the companies in the S&P 500 classified as growth were down in the three days to Monday’s close, according to data from S&P Dow Jones Indices, while almost 60% of the “value” stocks were up. There is a good case for a rotation out of growth and into value, because U.S. growth stocks have been doing
phenomenally well and value stocks—cheap stocks as measured by price-to-book, price-toearnings or price-to-sales ratios—far less well. Since the start of 2015 the Russell 1000 Growth index is up 65%, including dividends, while the value index returned only 30%.
Growth stocks are also extremely expensive, with the Russell measure trading at 21.4 times estimated operating earnings over the next 12 months, close to the post-Lehman high reached in January. Value stocks have been much cheaper in the past, but at 14.3 times earnings they remain far cheaper than growth.
A case based on valuations could and has been made many times in the past few years. At some point the fascination with
growth will break, but valuation is no guide to when.
Yet the second-quarter earnings reports of the FANGs-etc. offered a couple of pointers that shareholders might, just perhaps, be starting to shift away from the pursuit of growth at any cost.
Tesla is the most obvious example. Its shares jumped even as losses were bigger than expected, because it cut capital-spending plans, reduced cash outflow, and CEO Elon Musk showed some sensitivity toward Wall Street. Shareholders are more worried about future cash calls than they are excited about another round of expansion.
Amazon disappointed on revenue but produced better earnings than expected, and investors were delighted—plausibly the beginnings of the business’s shift away from growth in favor of profit, a trade-off every mature company eventually has to make. Still, Amazon is growing fast and investing heavily, so this is a tiny shift at the margin, at most.
Amazon also illustrated one of the dangers ahead for growth investors, as advertising became a significant contributor to revenue. The more the companies compete with each other—in Hollywood, artificial intelligence, self-driving cars or advertising—the lower their margins are likely to be.
Another danger for the biggest companies is the threat of government intervention—to limit their monopoly power, force them to pay higher taxes or apply old-world laws to cyberspace.
Only the last of those seemed to bother investors this quarter, with Alphabet stock shrugging off a $4.3 billion European antitrust fine and a higher effective tax rate. By contrast, Facebook shares were crushed because it expects to spend billions of dollars a year extra on “safety and security”—political imperatives after Facebook became the public face of election manipulation attempts and privacy abuse.
Just as the political perils apply more to some companies than others, so does the growth story, because these companies are at very different levels of maturity. Yet Apple’s blow-out results still had the power to renew confidence in growth stocks in general on Wednesday, helping all but one of the U.S. members of the NYSE Fang+ to rise. Better still for growth investors, the Russell 1000 Growth index had its thirdbest one-day performance against value this year. The FANGs-etc. story does not appear to be over yet, even if it is becoming a little more nuanced.