Best FANG Stocks to Buy Before They Rebound
We’re still bullish on shares of two of the four big tech companies.
As the stock market’s descent gathers steam, one group stands out for particularly atrocious performance: the FANGs. Yes, the same big-capitalization high-tech companies that kept the overall market out of negative territory in 2015 are now leading the market down, and they’re doing so despite no appreciable deterioration in their fundamental prospects.
Analysts maintain that the FANGs—Facebook (symbol FB, $99.54), Amazon.com (AMZN, $482.07), Netflix (NFLX, $86.13) and Alphabet (GOOGL, $701.02), the former Google—haven’t lost their bite. “They are all growth plays,” says Mark Mahaney, an analyst with RBC Capital Markets. “They are long-term oriented, make appropriate bets and have been good shepherds of investor capital. We like them all.”
We’re more bullish on Facebook and Alphabet than on the other two. But sentiment has turned against the entire group. And with their valuations high—in two cases, off-the-charts high—investors have sold mercilessly. Facebook and Alphabet, which both soared after delivering impressive fourth-quarter earnings reports, have sunk 14% and 10%, respectively, since their early February highs. Amazon, whose fourth-quarter results disappointed, has plunged 30% since late December. And Netflix has plummeted 34% since early December. (Prices and returns are through February 9.)
Until sentiment reverses course, the FANGs are likely to remain under pressure. But long-term investors may find the recent declines a great opportunity to pick up superb companies at better prices. These companies are doing the right things to remain innovative and competitive in an industry in which obsolescence is often just a click away.That has allowed all four of these companies to produce blistering revenue growth at a time when the average big company is struggling to just inch ahead. And although all have, to some degree or another, sacrificed short-term profits to achieve long-term goals, all have proven records of investing their cash wisely.
Consider Alphabet, the world’s most valuable firm, with a market capitalization of $482 billion. The company renamed itself last August and started reporting its financial results in segments – Google and “other bets”—to emphasize that it had become far more than a search and advertising concern. The new name was both a bow to language—the key to Google’s intuitive search engine—and a play on words. In announcing the reorganization, CEO Larry Page told shareholders that Google was making strategic bets to create “alpha,” investing jargon for above-benchmark returns.
During a conference call following the release of fourth-quarter results on February 1, the company revealed the size of these bets. Alphabet lost $3.6 billion on unprofitable start-up ventures, ranging from self-driving cars to computers that control home-energy use and technologies to help detect diseases early, when they can be cured more easily. “The whole idea is to fund these interesting projects, not necessarily to drive growth in Google, but to ultimately spin these off and create real businesses on their own,” says Neil Doshi, an analyst with Mizuho Securities. “That could really drive value in the long run.”
For the moment, however, the overwhelming majority of Alphabet’s revenues and all of its profits come from the Google side of the business, which includes YouTube, Google Play, Android, Chrome, maps, apps, cloud and, of course, search and advertising. Revenues for that segment of the business totaled $74.5 billion in 2015, compared with just $448 million for other-bets operations. Operating income for the Google segment amounted to $23.4 billion in 2015, up 23% from the previous year. Analysts on average estimate that earnings will rise 17%, to $34.51 per share, in 2016. The stock sells for 20 times that figure. That’s not too much for a company with so much growth potential, says Doshi.
Compared with Alphabet, Amazon appears to sell for an insanely high price: 106 times estimated 2016 earnings of $4.53 per share. But the valuation begins to make more sense when you realize that analysts expect profits to nearly quadruple this year and to nearly double in 2017, as Amazon continues to rack up big revenue gains while reducing spending on growth and building its infrastructure.
The oldest of the FANGs, Amazon has a 21-year history of pouring its profits back into the business, either by investing in loss leaders, such as the Kindle e-reader, or by building new warehouses to facilitate more-rapid delivery of goods to customers. But the company promised restless investors a year ago that it would ratchet down its spending to deliver better bottom-line results.
Still, investors reacted ferociously after the company reported fourth-quarter earnings that came up shy of expectations. The miss was mainly the result of the company’s drive to make sure that goods that were ordered just days before Christmas got under the tree on time. Amazon’s same-day and next-day delivery promises proved costly, but they’re a key ingredient in the plan to get consumers to pony up $99 annually for Amazon’s “prime” service. Prime has been wildly successful, with Consumer Intelligence Research Partners, a market-research firm, estimating that one in six American households have signed up. Doshi says the bump in delivery costs was a one-time blip caused by an unexpectedly heavy online shopping season, and he adds that he believes Amazon will keep its vow to rein in costs for the sake of profits. On that basis, he recommends the stock. His one-year price target is $685.
But Doshi acknowledges that investor patience with the company’s propensity to place costly bets on growth has grown thin. That creates a real risk with the stock, he says. “You can’t take a short-term view on Amazon,” says Doshi. “But if [CEO] Jeff Bezos said that Amazon was going to go back into deep spending mode, I do think that the shares would collapse.”
Facebook, which has been public for less than four years, reminds Mahaney of Google in its early days. Started as a way for college students to connect online, the world’s largest social network has now become an advertising powerhouse, and it has only begun to find ways to make money from its growing portfolio of businesses. With strategic acquisitions of companies that do everything from finding friends to helping you share photos, Facebook buried once-powerful competitors, such as Friendster and MySpace, and then made investors happy by boosting advertising revenue from a relative pittance in 2012 to $17.1 billion in 2015.
The company now brags that 1.6 billion monthly active users are on Facebook; 1 billion use its Wi-Fi-powered messaging service, Whats App; and another 400 million regularly use its photo-sharing site, Instagram. And although the vast majority of Facebook’s sales and profits come from advertising, the company has launched a wide array of futuristic projects, from virtual reality gaming via Oculus headsets to Internet access via a solar-powered plane. The opportunity to boost profits by finding ways to charge for some of its free services—or deliver more advertising through them—has barely been tapped, says Mahaney. That makes Facebook’s price-earnings ratio of 32, based on estimated 2016 profits, reasonable. “The stock’s valuation is more aggressive, but the growth is, too,” he says.
The riskiest of the four stocks is Netflix. Although the company has been wildly successful in creating a market for streaming in-home delivery of movies and television shows, with 45 million domestic subscribers, analysts worry that it is getting close to a saturation point that will spell slower growth in the future. CEO Reed Hastings is countering that by attempting to conquer the rest of the world, launching marketing efforts in 130 foreign nations. But rapid international expansion is a costly undertaking and may depress Netflix profits into 2017.
Mahaney thinks the international strategy will pay off for both subscribers and shareholders in the long run. Netflix’s 45 million domestic customers and 30 million international subscribers give the company an edge when negotiating for exclusive content, he says. The better the content, the easier it is to persuade subscribers to pay $8 to $12 a month for access to Netflix programs, which feeds a virtuous cycle. Adding international subscribers will boost Netflix’s bargaining power and fuel its revenue growth.
In the short term, however, the stock price is likely to prove dodgy. Mahaney says that his bullish take on the stock is based on his long-term view that the company will start pulling in profits amounting to $10 a share in the next three to five years. Such long-term calls are admittedly speculative. Still, Mahaney believes the shares will perform better than the market over the next year and thinks investors should buy now. Doshi recommends a wait-and-see approach, rating the shares a hold.