The FAANGs’ inherent diversification means that the tech stocks are durable in the face of changing market conditions, argues Alex Neilson.
For a decade, a select group of US growth stocks, known collectively as the FAANGs, were at the vanguard of the global bull market. All that changed last year, when a mix of political scandal (Facebook), poor Apple results and fears of monetary tightening led to a major sell-off.
Although results for the FAANGs this quarter have been mixed, since the end of December the broader trend has been towards recovery for these large market-beating companies.
It now seems clear that the slowdown at the end of 2018 had much more to do with general fears of higher interest rates than poor earnings or issues with company fundamentals.
The strength of the FAANGs is largely down to brand clout, and the fact that they are platforms, rather than single product businesses. They have great balance sheets and huge free cash flow, which allows them to buy other companies or develop new services from scratch.
The FAANGs’ inherent diversification means that they are incredibly durable in the face of changing market conditions. Apple is a good example: although global iPhone sales are falling, other parts of the business, for example services, such as Apple Pay, and wearables, such as the Apple Watch, are growing. These justify a degree of optimism over the company’s share price in the long term, and recent results, which were slightly better than expected despite further declines in revenues, back up this view.
Deliveries by drone
Google also benefits from a multiplicity of revenue streams. If search engine advertising revenue drops off, there’s always YouTube, Google Maps and countless other revenue streams. Recently, Google Wing became the first drone delivery service to win regulatory approval in the US - another exciting sign for the company.
That Google’s results fell slightly short is more a reflection of our lofty expectations of the company than any issue with the company itself. Google, like most of the FAANGs, is resilient. Notwithstanding a difficult first quarter, we still believe in Alphabet’s long-term value, and the valuation remains attractive.
Beyond the FAANGs, US growth stocks, particularly big tech companies, all recovered ground in the first half of 2019 as investors rotated allocations away from safety stocks towards growth. PayPal, Visa, Adobe, and Microsoft are all well placed to do well.
If there is a threat to big tech, it is from government regulation. Barely a month goes by without a news story that leads to calls for stricter rules for social media platforms, and this is certainly something to consider when assessing the long-term outlook for social media companies such as Facebook. For companies without a strong social media dimension - Microsoft, Adobe, PayPal and Alphabet - regulation isn’t such a concern.
In a low-growth global economy, investors will continue to pay a premium for the growth provided by cutting-edge companies. So although 2018 was challenging, the recovery tells a truer story than the dip.
Alex Neilson is investment manager at Investec Click & Invest.