FAANG is an acronym for some of the leading global (Western) tech stock names. The list includes Facebook, Amazon, Apple, Netflix and Google (now Alphabet). To get a truer sense of what tech stocks drive S&P 500 returns, one could add Microsoft to the mix.
And to get an even better, and more global, picture of tech stocks, on must look East, at the ‘BAT’ stocks, a less well used acronym for Chinese tech leaders Baidu, Alibaba and Tencent.
It is worth noting that the worst 3-year performance out of the above companies netted its investors 45% (Baidu) and the best returning stock over the last 3 years has been Amazon (279%). These innovative companies, and really tech stocks in general, have been the main drivers of global returns over the last few years.
But will this continue?
When considering these companies, the fundamental drivers of both user engagement (leading to revenue growth), and then ultimately earnings growth needs to be unpacked and is different for each company. We consider some of these companies.
Apple recently beat earnings expectations. And while sales volumes of their latest iPhone have declined, the phones have become more expensive and margins have increased. As an investor, it is worth considering whether this is sustainable. It might be, provided Apple technology and applications remain market leading, but should competitors such as Huawei and Xaomi offer the same or better features at vastly reduced prices, the revenue earned from hardware is under threat. Of course, Apple earns significant revenue from applications listed and accessed through its app store.
The user purchases (a game for example) through the app store and because the platform is provided by Apple they get approximately 30% of the revenue. So, provided users continue using the app store to access more content, revenue will continue to grow. Analysts don’t expect more than 8% pa revenue growth over the next 3 years for Apple, but they do expect margins to increase and for earnings per share to grow at 18% pa. The company trades on a forward PE of 19 times and it could therefore be argued that Apple is fairly valued and will struggle to make substantial gains from current levels.
Naspers investment, Tencent, is the worst performing stock over the last 6 months and quarterly results missed expectations. Post the results, however, the stock price has started to recover and investors must consider where the company is focused on growing revenues for the next 3+ years. In some cases (like some of Naspers’ investments) the product offering in focus has not even been monetised yet. This means the investment case hinges on the level of traction made and market share taken and then to try to predict what level of monetisation will be possible.
Looking at Amazon, most analysts talk about how expensive the share is by looking at its price relative to its earnings. The reality is that some of Amazon’s offerings are in their infancy and while they might contribute revenue, the company is using that revenue to expand footprint and invest in growth, so very little of it is hitting the earnings line.
At some point in the future, the company will stop growing into new regions/ offerings at which revenue will drop down to the earnings line - and quickly. This began to happen in Amazon’s last quarter already. Revenue only grew at 4% quarter on quarter but earnings grew 55%. With Amazon’s market leadership in cloud, the future remains bright for the company.
Even though Netflix is the second highest returning stock over the last year, it has very high debt and their content is expensive and not necessarily scalable - users typically watch a TV episode once or twice. More costs incurred by Netflix are spread over viewers. It therefore needs to keep adding more viewers to spread the costs, therefore the company’s fundamentals are more questionable.
Currently, there are a few question marks on the sector, however, these companies continue to take share in ‘eyeball’ time and continue to innovate.
As such, provided the investor can take the volatility in these stocks and focus on the fundamentals, the outlook is good (for most of them).