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PRINT EDITION
How much bite do the FAANG stocks have?
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U.S. tech titans' recent results show they're all profitable, but their business models and prospects vary greatly
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By GORDON PAPE
  
  

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Tuesday, August 14, 2018 – Page B6

Back in 2000, most investors believed all high-tech stocks were cut from the same cloth. There was little to choose from between AOL, 360Networks, Pets.com, Excite, GeoCities and the dozens of other companies that were publicly listed at the time. They all were part of the fascinating new world of the internet and people wanted in on the action at whatever price.

So when the dot-com bubble burst in March of that year, the whole sector went down in flames. Over half the dot-com companies disappeared between 2000 and 2004. More than US$5trillion in market capitalization was lost. The Nasdaq Composite Index dropped 77 per cent between March, 2000, and October, 2002.

Investors were left shellshocked. Many vowed to never again invest in the tech sector.

Some are convinced to this day that all technology stocks are money losers and are about to suffer another horrific collapse.

For example, here's an excerpt from an e-mail I recently received from a reader: "Why does it make sense to invest in such companies as the FAANG stocks (Facebook, Amazon, Netflix, etc.) when most of them are not yet generating profits? Is it a pure speculation that in the future they will be finally profitable? I have not yet started to invest in these companies because they make me afraid."

I can understand our reader's concern and certainly some of these stocks look very pricey right now. But there are some huge differences between 2000 and today.

For starters, the majority of publicly traded tech companies are profitable, some immensely so. That includes all the FAANG stocks. Every one of them reported second-quarter earnings in the millions or billions of dollars.

They may have other problems, but profitability is not one of them.

Let's take a quick look at the latest results from the FAANG list.

FACEBOOK INC. (FB-Q)

Facebook stock dropped dramatically in late July after the company released second-quarter results. At first glance, investors might be left scratching their heads as to why. Revenue was up 42 per cent year-over-year to more than US$13-billion. Profit increased 31 per cent to US$5.1-billion (US$1.74 a share, fully diluted). Yet, the stock plunged by more than US$41 (about 20 per cent) on the day after the figures were released. What happened?

This is a classic example of investors looking forward, not back.

Sure, the latest quarter looked good. But the company warned of slowing revenue growth for the remainder of the year. One analyst referred to the guidance as a "nightmare." Plus, user growth is slowing. About 2.5 billion people use one of Facebook's products already, so there's not much room left for expansion.

The company is also struggling with its image after the Cambridge Analytica scandal and growing concerns over user privacy.

Conclusion: Facebook will continue to be highly profitable, but it appears to be reaching its limits of growth. That's a killer for a momentum stock.

APPLE INC. (AAPL-Q)

In contrast with Facebook, Apple shares jumped in value after the company released third-quarter results for fiscal 2018 on July 31.

The price surge pushed Apple's market capitalization to more than US$1-trillion, the first U.S. company to crack through that barrier.

The company posted quarterly revenue of US$53.3-billion, an increase of17 per cent from last year.

Earnings per diluted share were US$2.34, up 40 per cent year-overyear. Surprisingly strong sales of high-end iPhones drove the increases in revenue and profit.

Apple also offered a bullish forecast for the fourth quarter, predicting revenue would come in between US$60-billion and US$62-billion.

The stock price gained US$11.21 (about 6 per cent) after the results were released and have been trending higher since.

Conclusion: The company is on a roll, and even with the upward move in the price, the stock still trades at a reasonable P/E of 18.7.

The one cautionary note is the company is heavily dependent on the iPhone to drive future growth.

If sales should falter, the stock will get hit.

AMAZON.COM INC. (AMZN-Q)

For years, the knock against Amazon has been that its great revenue growth was never reflected in profit. That's now changing. Sales continue to increase, coming in at US$52.9-billion (up 39 per cent from a year ago) in the second quarter. No surprise there. But profit took a huge jump, rising to US$2.5-billion (US$5.07 a share, fully diluted), compared with US$197-million (40 US cents) in the second quarter of 2017. The industry consensus was for earnings of US$2.48 a share.

Analysts reacted positively to the results, with several increasing their target prices on the stock. Both Bank of America Corp. and JPMorgan & Co. predict a price in the US$2,200 range next year.

The share price keeps rising, hitting an all-time high last week of US$1,914.57 before retreating a little to close on Friday at US$1,886.30.

Conclusion: There appears to be no stopping this company, despite increased online competition from Walmart Inc. and others. The main concern is the high price of the stock, which currently has an out-of-sight trailing priceto-earnings ratio of 145.5.

NETFLIX INC. (NFLX-Q)

Netflix reported second-quarter profit of US$385-million (85 US cents a share, fully diluted). That was a big improvement over 15 US cents the year before, but investors were more interested in new subscriber numbers, which came in well below expectations. The company also lowered its projections for user growth for the rest of the year.

The stock was hammered as a result, dropping more than US$20 a share after the results were released. It has continued to decline since, closing on Friday at US$345.87. That's down18 per cent from the all-time high of US$423.21, reached in late June.

Conclusion: With any momentum stock, a slowdown in growth is bad news. We saw it with Facebook and we are seeing it here.

Like Amazon, it has a wildly inflated P/E ratio (152.4). Unlike Amazon, it is not displaying the growth needed to justify the share price.

ALPHABET INC. (GOOGL-Q)

This is Google, the "G" in FAANG.

The company changed its name a few years ago, so technically these stocks should now collectively be referred with the acronym FAAAN, but that hasn't caught on.

Whatever the name, the company is performing well. Secondquarter results beat estimates.

Revenue was US$32.7-billion, up about 26 per cent from just more than US$26-billion in last year's same quarter. Profit declined to US$3.2-billion (US$4.54 a share, fully diluted) from US$3.5-billion (US$5.01) in the prior year. However, that included the cost of a US$5.07-billion fine assessed by the European Commission for violation of competition laws, which the company is expected to appeal. Stripping out that cost, Alphabet made US$8.3-billion (US$11.75) in the quarter.

The stock rose after the release of the results, then retreated a little to the current level of US$1,252.51. RBC Dominion Securities raised its target on the stock to US$1,400.

Conclusion: There is no sign of a slowdown here. The main concern is corporate overreach; this is the second time that the company has been hit by huge fines from Europe over competition laws.

As you can see, all the FAANG companies are profitable. However, their business models and prospects are quite different, so they do not move in lockstep; each stock must be assessed on its own merits. This is not 2000 redux. The technology business has changed dramatically in the past 18 years.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.

For more information and details on how to subscribe, go to buildingwealth.ca.

Associated Graphic

People chat in front of a Facebook booth at a developer conference in San Jose, Calif., in 2017. Facebook's latest quarterly earnings looked solid, but investors were spooked by warnings about slowing revenue growth for the rest of the year, as well as slower user growth.

NOAH BERGER/AP


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