What Now for the FANG Stocks?

published 27 September 2016

In February, when jittery markets sent the shares of the so-called FANG stocks plunging, Kiplinger recommended snapping up shares of all four: Facebook, Amazon.com, Netflix and Alphabet (formerly known as Google). The fabulous four had trounced the market in 2015, and all four seemed full of promise as the new year got under way, and the early pullback gave investors a chance to buy in at relatively depressed prices.

All four have delivered double-digit percentage gains since then. And although their near-term prospects have dimmed as a result of the run-up in their share prices, they’ve got plenty of long-term bite. “There is less opportunity for the FANG stocks, but we still like all four,” says Mark Mahaney, a technology analyst with RBC Capital Markets.

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Facebook (symbol FB, $128.65, HOLD). The social networking phenomenon continues to grow at a blistering pace. In 2012, when Facebook went public, the company generated revenues of $5.1 billion. This year, analysts forecast, the company will produce revenues of $27.1 billion. Earnings of $53 million, or $0.01 per share, in 2012 are expected to reach $11.3 billion, or $3.94 per share, this year and $5.06 per share in 2017. The stock has more than tripled from the initial offering price of $38 and has soared sevenfold from its September 2012 low of $17.55.

Launched as a way to help college kids meet and form friendships, Facebook quickly turned into a popular advertising platform and has used its copious profits to gobble up complementary competitors, such as Instagram and WhatsApp, as well as companies with helpful technology. Among the dozens of firms folded into Facebook in recent years are Face.com, which makes facial-recognition software; Spool, a mobile bookmarking company; and Spaceport, which facilitates electronic gaming across multiple platforms.

These combinations help Facebook increase engagement among its 1.6 billion active users, and active engagement helps the company mine more data on its users, tracking their preferences for everything from automobiles to politics. This information allows Facebook to direct advertisements to the users of its popular consumer platforms – Facebook, Messenger, Instagram and WhatsApp. And that enhances Facebook’s appeal to advertisers.

Morningstar analyst Ali Mogharabi expects Facebook’s revenues and profits to continue to grow rapidly as mobile advertising expands and the company finds more ways to get commercial messages in front of the right users. But the stock, selling at 29 times estimated year-ahead earnings, already reflects those rosy growth prospects, he says. And the share price is in line with Morningstar’s estimate of Facebook’s true worth. Says Mogharabi, “There is nothing negative about this company. We just think all the positives have been priced in.” If you own the stock, sit tight, he suggests. But he recommends against buying unless the shares drop below $77.

Amazon.com (AMZN, $775.10, BUY), which began as an online bookseller in 1995, today sells everything from catnip to mice (for computers). And it does it so well that consumers equate the brand with low prices, large selection, convenience and superior customer service – a rare combination among retailers, says Morningstar analyst R.J. Hottovy. That has fueled annualized sales growth of 19% over the past five years and has triggered a shakeout in brick-and-mortar retail competitors, ranging from Borders to Circuit City. There’s no reason to think Amazon’s breathtaking revenue growth will end anytime soon. Even when consumers spend less, Amazon delivers sales gains by boosting its market share, Hottovy says.

The catch is that Amazon’s profits have never been as impressive as its customer service, mainly because the company has kept its profit margins razor-thin to boost sales and has invested in loss-leaders such as its Kindle e-readers and Fire phones. That may be changing, however. At a time when most online retailers gain the bulk of their sales through web searches, Amazon is increasingly becoming a starting point for purchases, much like “an anchor tenant in a mall,” Hottovy says. That takes away some of the pricing pressure that has held down Amazon’s profit margins. Moreover, Amazon has started offering cloud-computing services to corporations – a highly profitable business that is already ringing up nearly $8 billion in annual sales. Hottovy expects Amazon’s cloud revenues to grow at an annual pace of 35% over the next five years.

All this bodes well for Amazon’s overall profit prospects. Earnings are expected to climb 360% this year, to $2.8 billion, or $5.76 per share, and to jump another 81% in 2017, to $10.40 per share. With such scorching bottom-line growth, Hottovy says, the stock seems reasonably priced, even though it sells for 100 times forecast year-ahead profits. He thinks Amazon is worth $900 per share– a 14% premium over today’s price.

Netflix (NFLX, $98.06, BUY), a provider of digital entertainment, has taken investors on a wild roller coaster ride almost since the day it went public, in 2002. At the outset, Netflix provided a subscription service that sent movies by mail – an innovative concept at a time when video rental stores were as ubiquitous as coffeehouses are today. CEO Reed Hastings’s commitment to take the unbeaten path is what has made the company successful and the stock so volatile.

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Indeed, the downfall of Netflix has been predicted nearly every time a new competitor arrived, the company raised subscription prices, or Hastings opted to plow profits back into the business to, for instance, go digital or finance proprietary content. The company’s decision to gradually hike subscription rates last year, while simultaneously building international operations, is the latest worry that set Netflix stock tumbling.

To be fair, the price hikes caused subscriptions to grow more slowly than they have in the past, and heavy investment in international expansion is pushing down profitability. Both developments understandably unsettle shareholders, says RBC Capital’s Mahaney. But the stock is down 25% from its all-time high of $131, set in December 2015, providing an opportunity to buy at a favorable price, he says.

Netflix is a leader in mining customer data, tracking everything from how long subscribers stay on the site to whether they fast-forward through movies. Because Netflix knows a great deal about its users, it can make recommendations to customers about shows they might want to watch – and make wise decisions about what content will be popular enough for Netflix to buy or produce. From original series, such as “Orange Is the New Black” and “House of Cards,” to revitalized programs, such as “Arrested Development,” Netflix uses customer data to make its subscriptions a compelling buy.

That’s why Mahaney thinks the slowdown in Netflix’s growth because of recent price hikes will only be temporary. “As we move beyond the price increase, we think the company will successfully launch in a number of international markets,” he says. “When it does, you’re going to see a lot more investor enthusiasm. This is a stock I could see doubling in the next three years.”

Netflix’s profits are still modest, expected to ring in at $123 million, or 29 cents per share, in 2016. But profits are expected to jump dramatically after that, to $0.87 per share in 2017 and $1.75 per share the following year. The stock sells for a pricey 200 times year-ahead earnings, but because earnings are so low, the figure is practically meaningless. As with Amazon, traditional measuring sticks may not apply here. Mahaney unabashedly recommends the stock for long-term investors.

Alphabet (GOOGL, $765.70, BUY ), the parent of Google, operates such a successful search engine that its name has become a verb. That has made Alphabet a hit among advertisers that want to strategically place pitches in front of people searching for everything from cars to contractors. Alphabet dominates search and search-related advertising, with roughly 80% of this fast-growing market. It also owns YouTube, the Android operating system and the Chrome web browser, among other things.

What’s more, Alphabet invests in “moon shots,” ranging from self-driving cars to smart home technology through Nest thermostats and home security systems. These incubator businesses, which include life sciences, venture capital and high-speed internet lines, lose money overall, but they keep Alphabet on the cutting edge of new technologies that have the potential to become stand-alone businesses in the future, says Morningstar’s Mogharabi. Industry experts believe self-driving cars will eventually become a multibillion-dollar industry.

The shares have jumped 13% since Kiplinger recommended them in February. Still, at 20 times estimated earnings, they look downright cheap compared with the other FANGs. And given projected earnings growth for Alphabet of 16% this year and 19% next year, the stock is a worthwhile holding for long-term investors.