The best trade for technology investors of 2015 is off a bumpy start in the new year. Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Alphabet's Google (GOOGL), known collectively as FANG, averaged an 83% gain last year while the overall market barley budged.
But so far in 2016, the popular group of stocks has lost more than 9% each on average through Wednesday, slightly lagging the 8% drop in the S&P 500.
The best-performing stocks from one year rarely outperform the following year, but could FANG break the pattern? After all, each of the four companies continues to dominate at least one massive and growing market, whether it's Facebook's reign over social networking, Google and digital ads, or Netflix and streaming video. Amazon has a grasp over two: e-commerce and cloud computing.
Investors last year certainly recognized the four for their success. The gains made by just those four stocks collectively added 3.7 percentage points to the return of the S&P 500 Index for the year, according to Yahoo Finance calculations with data from S&P. The index only gained 1.4% for the year, so absent the FANG group, the benchmark would have shown a loss for 2015.
But the superior gains have also driven the stocks to hefty market capitalizations and pricey valuations, increasing the risks for investors looking to the future. And the strong performance has created the kind of uniformly positive outlook on Wall Street that can also signal excessive optimism. Not a single one of the dozens of analysts covering Facebook, Google or Amazon rates any of the three a "sell" currently, according to FactSet. Just 3 of 42 analysts following Netflix rate it a "sell."
In the entire U.S. stock market, Google's $488 billion market capitalization trails only Apple (AAPL). Amazon, at $273 billion, and Facebook, at $270 billion, are both in the top 10. Netflix, at $45 billion, remains a relative pipsqueak by that measure.
But on price-to-earnings ratios, Netflix is more impressive, trading at a jaw dropping (to some) 282 times its profits. Amazon, too, trades at an almost unheard of 843 times profits. Both numbers are deceptive, however. Amazon CEO Jeff Bezos and Netflix CEO Reed Hastings are both known for steering potential profits back into their businesses to fuel growth instead of the bottom line. Facebook's P/E of 96 and Google's of 33 seem positively down to earth compared to Amazon and Netflix, while the entire S&P 500 trades at 20 times profits.
"It's a challenge when you're investing in companies that generally are in favor and executing well," says Tony Ursillo, an equity analyst at Loomis Sayles. "Sentiment tends to drive the stocks to valuations levels that in the short term might be extended."
But Ursillo and other investors with a long-term outlook say that despite the recent drops, they still favor the four stocks. Few other tech companies are growing as quickly and -- barring a recession -- nothing has appeared yet to slow them down.
"I still feel confident and very bullish on these companies," says Paul Greene, manager of the T. Rowe Price Media & Telecommunications Fund. The strong performance of 2015 is irrelevant to Greene, though. "I never look at the past [performance]," he says. "If you did that at any point in time for a company like Amazon or Netflix, you would probably miss out on a lot of the return." (As of Dec. 31, the $3.6 billion fund's top holding was Alphabet, second-biggest position was Amazon and Facebook was its 8th-largest holding. The fund hasn't disclosed smaller positions since Sept. 30, when it held $55 million worth of Netflix shares.)
That's not to say the volatility won't continue, especially as the overall markets remain in turmoil amid growing fears that the global economy could slip into recession. Peter Bourbeau, co-manager of the large-cap growth and all-cap growth strategies at ClearBridge Investments, says he has "zero clue" if the FANG stocks will beat the market this year, but says they'll still be outstanding bets over the long term.
"In calendar 2014, Google did zero, Amazon was dreadful," he says. "They kind of go up in a stair step fashion. It’s not going to be linear.”
Risks ahead
Still, that's not to say that long-term investors aren't on the lookout for for specific risks that could change their outlook.
U.S. and European antitrust regulators could pose a challenge to further growth, particularly at Facebook and Google, which have relied on some critically important acquisitions in the past, including Instagram, YouTube, and even the Android software for smartphones.
"You wouldn't want to see the EU and [Department of Justice] breathing down their necks on every deal," says Clearbridge's Bourbeau.
At Google's parent Alphabet, the company plans to start separating the results of its money-losing, long term bets from its core search and advertising businesses starting with its upcoming fourth-quarter report. That could demonstrate the growing profits of the core businesses, which include search, Android, YouTube and display ads. But it could also highlight how much money is being sucked up to develop self-driving cars, Internet service via blimps and a cure forcancer.
The new disclosures could hurt the stock more than they help it, says Scott Kessler, an analyst at S&P Capital IQ. "A lot of the good news is already in the stock," Kessler says. "And a lot of these experiments are going to look somewhat premature at this point."
Amazon benefitted from Bezos's decision last year to invest a little less in new businesses and report some actual profits on the bottom line. But the CEO could decide to return to heavy investment mode in 2016, says Loomis analyst Ursillo. And while that wouldn't change his long-term positive outlook on the stock, investors with a different time horizon might get jumpy.
"In the short run, if you're expecting that margins are going to ramp up materially, they may not," he says. "And that's probably not going to be received well by investors."
Netflix, which just announced an earlier-than-expected expansion into 130 new countries, including India and Russia, could run into problems if its subscriber growth rate slows. Hollywood could also become a challenge as some movie and TV moguls have made noise about charging Netflix more or withholding some popular content to help prop up the cable industry.
What's next?
Even as they fret about FANG's outlook, investors are searching for the next set of superior stocks. RBC Capital Markets has already picked a mix of new and old favorites and created a new acronym, BAGEL, which (imperfectly) stands for Alibaba (BABA), Amazon, Google, Expedia (EXPE) and LinkedIn (LNKD).
LinkedIn, the premier site for recruiting and job networking, deserves "equal billing" with the FANG stocks due its dominant position and strong management team, says Ursillo. "There's really no other professional networking site out there to compete with them long term," he says.
Beyond the BAGEL stocks, some investors point to Microsoft (MSFT) as a possible outperformer this year. It did quite well last year -- the stock gained 19% -- and it's P/E ratio is a more modest 17, attracting some investors with concerns about FANG's outlook. CEO Satya Nadella has pivoted the software giant away from some of his predecessor Steve Ballmer's defensive moves and toward high-growth areas like cloud services and mobile apps. "He’s deemphasized all of Ballmer’s nonsense and he’s emphasizing the cloud,” says Bourbeau, a Microsoft fan.
Travel site operator Priceline Group (PCLN) lost 2% last year, even as sales grew 11% over the most recently reported 12 months. Some investors are worried about growing competition for hotel bookings from the still-private home and apartment sharing service, Airbnb, but that threat has been exaggerated, says T. Rowe manager Greene, whose firm has invested in both companies. That will become clear once Airbnb eventually decides to go public and investors can compare financial results on an even footing, he says.
"We used to say one of the best things for Google's stock price would be if Facebook could come public," he notes, recalling when similar competitive fears of a rising but private competitor dogged the search giant. "The same is true here."
