For more than 12 years, growth stocks have been the talk of Wall Street. That's because historically low lending rates and ongoing quantitative easing from the nation's central bank have rolled out the red carpet for fast-paced companies to borrow and expand.
But among growth stocks is a subset of exceptional performers that have truly outpaced the market since the end of the Great Recession. I'm talking about the FAANG stocks.
The FAANGs have run circles around the broader market
The FAANG acronym stands for:
- Facebook (NASDAQ:FB)
- Apple (NASDAQ:AAPL)
- Amazon (NASDAQ:AMZN)
- Netflix (NASDAQ:NFLX)
- Google, which is now a subsidiary of Alphabet (NASDAQ:GOOGL)(NASDAQ:GOOG)
Since the benchmark S&P 500 bottomed out on March 9, 2009, it's gained 555%, through this past weekend. By comparison, the FAANG stocks have left the broader market in their dust over this same time frame:
- Facebook: Up 972% since IPO in 2012
- Apple: Up 5,628%
- Amazon: Up 5,624%
- Netflix: Up 10,615%
- Alphabet: Up 1,853% (Class C shares, GOOG)
If you're wondering why these companies have outperformed the market by such a wide margin, it likely has to do with their innovation, competitive advantages, and leading market share in their respective industries.
But even among the FAANG stocks there can be winners and companies worth avoiding. As we near the homestretch for 2021 (i.e., the fourth quarter), two FAANG stocks stand out as clear buys while another might be best off avoided.
FAANG stock No. 1 to buy in Q4: Facebook
The first of the group that I don't see as anywhere close to having reached its full potential is social media giant Facebook.
The biggest objection to overcome with Facebook is its warning that growth would slow in the second half of 2021. This cautionary tale has been fairly consistent of late for growth-oriented stocks as higher vaccination rates have encouraged people to get out of their homes. However, Facebook's conservative outlook doesn't overshadow its social media dominance or the growth levers it's yet to pull.
When the June quarter ended, this company had 2.9 billion monthly active users (MAUs) visiting its namesake site, along with 610 million additional unique MAUs visiting WhatsApp and/or Instagram, which Facebook also owns. That's north of 3.5 billion MAUs, or about 44% of the global population. Advertisers are well aware there's not a platform on this planet they can go to that'll provide them with a way to reach a broader audience with their message. This gives Facebook incredible ad-pricing power in virtually any economic environment.
The crazy thing about Facebook is that it's on pace to bring in more than $100 billion in ad revenue this year, yet has only monetized two of its four core assets. While its namesake site and Instagram produce ad-driven revenue, WhatsApp and Facebook Messenger aren't meaningfully monetized. Pulling these levers could send Facebook's operating cash flow to new heights.
And there's more. The company is angling to be a leader in virtual reality (VR)/augmented reality. Although sales for its VR Oculus devices aren't broken out in its quarterly reports, "Other" category revenue, which includes Oculus, has jumped 85% through the first six months of 2021 to $1.23 billion.
I'm simply not buying into the thesis that we'll see significant slowing from Facebook anytime soon. That makes its forward-year price-to-earnings ratio of less than 23 an absolute steal.
FAANG stock No. 2 to buy in Q4: Amazon
The second FAANG stock to pile into for the fourth quarter is e-commerce kingpin Amazon.
The story with Amazon is exactly the same as Facebook. The company anticipates slowing growth in the second half of the year as buying habits shift and people leave their homes with greater frequency due to rising coronavirus vaccination rates. However, with the company dominating two key industries and seeing no slowing in its highest-margin segments, any weakness in Amazon should be viewed as a reason to pounce.
What do I mean when I say dominant? Approximately $0.40 of every $1 spent online in the U.S. this year is expected to route through Amazon's marketplace, according to a report from eMarketer. That's more than five times the online retail sales share of its next-closest competitor.
Despite retail margins generally being tiny, the company has been able pivot its e-commerce dominance into signing up 200 million people worldwide to a Prime membership. These memberships help Amazon out two ways. First, it encourages members to stay within the company's ecosystem of products and services. But arguably more important, it provides fee revenue that helps the company lift margins and undercut brick-and-mortar retailers on price.
Amazon is also the undisputed leader in cloud infrastructure services. Amazon Web Services has an annual sales run-rate of more than $59 billion, as of Q2 2021. In the first quarter, AWS accounted for close to a third of global cloud infrastructure spending.
Furthermore, Amazon's growth concerns revolve around its online retail operations. Although this is the company's primary revenue generator, e-commerce yields low margins. Meanwhile, AWS, advertising revenue, and subscription fees aren't slowing down and offer substantially higher margins. In short, Amazon's sales growth might slow, but its operating cash flow growth isn't tapering -- and cash flow is far more important in valuing this stock.
The one FAANG stock to avoid in Q4: Apple
On the other end of the spectrum, it's my suggestion that investors avoid the largest publicly traded company in the world, Apple. Keep in mind that when I say "avoid," I don't mean short-sell it or even sell your existing long-term holdings. Rather, I see an opportunity for Apple to pull back in the months that lie ahead, which could offer a more attractive future entry point for patient investors.
As a whole, I believe Apple to be a well-run business. It has the leading share of smartphone sales in the U.S., is one of the most-recognized brands worldwide, and customer loyalty isn't an issue. In fact, every product launch for as far back as I can recall has been met with lines that wrap about its retail stores.
To boot, Apple is in the midst of a long-term transition to become a services-focused company. Pushing subscriptions will help reduce the revenue lumpiness associated with device replacement cycles and should ultimately lift the company's operating margins.
Although it's a great company, there are two reasons to believe its valuation could come down modestly in the fourth quarter. First, it's going to be up against record iPhone sales comparisons. Apple began selling its first 5G-capable iPhone during the fourth quarter of 2020. Even though it just unveiled its newest 5G iPhone models this past week, the big jump in download speeds that consumers and businesses had waited a decade for occurred last year. While sales of the iPhone should continue to generate huge amounts of operating cash flow, Apple has a tough task of growing its top-selling product.
The second reason Apple could be worth avoiding in the fourth quarter is tax related. Democrats in the House of Representatives and Senate are looking to pass a larger infrastructure bill that'll almost certainly entail higher corporate tax rates. At minimum, we're liable to see the peak marginal corporate tax rate rise from 21% to 25%.
While this is a nominally small increase, Apple's sales and earnings per share are only expected to respectively grow by 4% and 2% in 2022, according to Wall Street. This suggests higher corporate tax rates could actually send Apple's EPS into reverse next year. With the company valued well above its five-year averages in price-to-sales, price-to-earnings, and price-to-cash flow ratios, it looks like a good bet to retrace and offer a more attractive entry point for future buyers.