For much of the past decade, the stock market has been on fire. Over the trailing 10 years, the iconic Dow Jones Industrial Average, benchmark S&P 500, and technology-dependent Nasdaq Composite have respectively returned 166%, 209%, and 390%.
However, a significant portion of these gains have come from the FAANG stocks.
By FAANG, I’m referring to:
With the exception of Facebook, which went public in 2012, the 10-year trailing returns for these companies are as follows:
- Facebook: 762%
- Apple: 967%
- Amazon: 1,670%
- Netflix: 1,430%
- Alphabet: 780%
Imagine having the weakest horse of the bunch (Alphabet) and still gaining an annualized average of 24% over the course of a decade. That’s more than triple the historic average annual return rate of the S&P 500.
While the FAANG stocks have been nothing short of unstoppable for a long time, some look more attractive moving forward than others. As we move headlong into May, two FAANG stocks offer must-buy appeal, while another has the look of a company that should be avoided for the time being.
The first FAANG stock to buy: Facebook
To begin with, social media behemoth Facebook made it crystal clear with its first-quarter operating results that it’s the best value among the FAANGs.
The company’s namesake site brought in 2.85 billion monthly active users (MAUs) during the first quarter, with Instagram and WhatsApp also mustering a combined 600 million unique MAUs. Together, that’s 3.45 billion MAUs. To put this into some context, 44% of the world’s population visited a Facebook-owned asset at least once a month in Q1. The breadth of Facebook’s audience, as well as the data targeting it can provide, makes it the unquestioned destination for advertisers. After growing ad revenue by 21% in 2020 — during the worst economic downturn in decades — ad revenue soared 46% in the first quarter.
Now, here’s the real kicker: Of the $25.4 billion in ad revenue brought in during Q1, most came from its namesake site and Instagram. Neither Facebook Messenger nor WhatsApp have been meaningfully monetized as of yet. This means Facebook is growing by 20% to 25% annually with only half of its major assets contributing in a meaningful way. Imagine how robust profits and cash flow will be when WhatsApp and Facebook Messenger are monetized.
Also, don’t overlook ancillary sales channels. In particular, Facebook’s “Other” category — which is home to its Oculus virtual reality devices, among other things — saw 146% year-over-year revenue growth in Q1 to $732 million.
The point is this: Facebook can be purchased for about 22 times next year’s earnings, yet it’s continuing to grow by 20% or more each year. That’s an unheard-of level of cheap for such a high-growth company.
The second FAANG stock to buy: Amazon
The other FAANG stock that’s demonstrated it’s a no-brainer buy is e-commerce giant Amazon. Like Facebook, Amazon reported its most recent quarterly results this past week.
A common theme among FAANG stocks is industry dominance. Whereas Facebook owns four of the six most-visited social sites in the world, Amazon controls an estimated 39.7% of all online market share in the U.S., according to a March 2020 eMarketer report. In other words, an estimated $0.40 of every $1 spent online in the United States is going through Amazon. That’s in the neighborhood of 33 percentage points higher than its next-closest competitor.
Admittedly, retail margins aren’t all that great. To supplement this, Amazon has enrolled more than 200 million people worldwide in Prime. The fees Amazon collects from Prime help the company undercut brick-and-mortar retailers on price. Plus, paying members have a propensity to spend more within Amazon’s ecosystem, as well as stay loyal to its products and services. On an annual run-rate basis, subscription services now tops $30 billion in revenue.
However, the real star here looks to be cloud infrastructure segment Amazon Web Services (AWS). Sales for AWS catapulted 30% higher in full-year 2020, and gained another 32% in Q1 2021 from the prior-year period. Because cloud margins are substantially juicier than retail margins, AWS becoming a larger percentage of total sales will result in Amazon’s cash flow skyrocketing.
Amazon isn’t cheap by traditional metrics, but it’s historically inexpensive when taking into account forecast cash flow. Amazon ended every year of the 2010s with a price-to-cash-flow multiple ranging from 23 to 37. Based on Wall Street’s consensus cash flow estimate for 2024, Amazon is only valued at a multiple of roughly 12 times cash flow. That makes it a screaming buy, and a good bet to overtake Apple as the world’s largest publicly traded company.
The FAANG stock to avoid: Netflix
On the other side of the aisle, I’d suggest streaming content provider Netflix is the FAANG stock to avoid in May (and moving forward).
Obviously, a company doesn’t grow to a $226 billion market cap without doing something right. Netflix has done an exceptionally good job of building up its domestic and international subscriber base prior to and during the pandemic. It’s also improved existing subscriber loyalty by creating plenty of original programming.
However, Netflix is set to face three pretty sizable hurdles in 2021 and beyond.
First, it’ll likely be contending with slower subscriber growth as developed countries like the U.S. emerge from the pandemic. When lockdowns were in effect one year ago, people were lining up to subscribe to Netflix to pass the time. With developed nations well underway with their coronavirus vaccination campaigns, getting out of the house is now the focus for hundreds of millions of consumers. That translates into slower subscriber growth for the company.
Second, competition continues to pick up in an industry with a relatively low barrier to entry. Walt Disney‘s streaming service, Disney+, took only 16 months to go from launch to more than 100 million subscribers. By comparison, Netflix ended the first quarter with 208 million paid memberships. It’s not out of the question that Disney+ eventually catches up to Netflix in the subscriber column. Tack on Alphabet’s YouTube, which is generating as much revenue on an annual run-rate basis as Netflix, and you have a recipe for slower growth as competition picks up.
Third, Netflix was a constant cash burner until 2020. I’ve always believed the best way to measure the value of the FAANG stocks is by examining their cash flow multiples. That works well with Facebook, Apple, Amazon, and Alphabet. It doesn’t, however, work with Netflix. That’s because Netflix is putting a lot of cash to work in international expansion efforts and has been cash-flow negative through 2019. While these are efforts I can appreciate, Netflix simply doesn’t merit its lofty valuation relative to its tempered growth prospects.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.