FAAMG and the next tech bubble

Summary:

  • The most important tech stocks have been instantly hit by new research studies.
  • Momentum might have took the place of growth in the recent development of the FAAMG stocks.

What happened to tech stocks last Friday?

Nowadays, when you speak of the leading companies in tech, you refer to FANG, composed of Facebook, Amazon, Netflix and Google. All four enterprises have experienced a rally in the stock market that brought more than 20% increase in their shares’ market price in the last year. However, their rally took an important, but misguided, loss this Friday, after both UBS and Goldman Sachs have published their research papers on the current situation of the tech sector, and compared its metrics to the tech bubble in 2000. Just a couple of hours after the publication, Netflix dropped up to 5%, while the others lost between 3% and 4%. By the end of the day, they recovered to an average loss of 3%, which still seems surprising as both publishers had a rather neutral view over their evolution.

When Goldman Sachs speaks, you listen: is there a tech bubble around the corner?

An interesting aspect of the research papers is that both promote a harder to pronounce name, FAAMG, as the new acronym of leading tech companies. It adds Apple and Microsoft to the big names, and takes out Netflix because it is considered to not have a substantial impact on the S&P 500. The FAAMG stocks are responsible for 37% of the YTD performance of S&P 500 and for an astonishing 55% of the YTD performance of Nasdaq, evoking memories (more probably nightmares) of the last Nasdaq rally run in 2000. These five companies have added a total of $600 billion of market cap in the last 12 months, almost equivalent to the GDP of Switzerland. Since 1993, there have been four years with a comparable “clustering” of returns in S&P 500: 1993, 1999, 2005 and 2007. Seems familiar?

But what is the problem here? These FAAMG stock have been considered for a long time to be growth stocks, meaning that investors prefer them because they expect the share price to go up. Historically, this type of stocks has part of more volatility than the rest of the market, as these companies are involved in innovative and risky markets that usually don’t return steady profits.

What both publishers highlight is the lack of volatility in the soaring tech stocks, which has been even lower than the volatility of the average Consumer Staples & Utility stocks, considered the “boring” safe options.

This lack of volatility increases the confidence of investors into these stocks, but it can always turn into a trap. FAAMG is likely to continue to have higher than average returns in the long term, but we shouldn’t expect the ride to be always smooth. It’s one thing to bet on growth, and a completely different thing to bet on momentum. Momentum has taken over, while fundamental growth might need a break to catch up.

The most positive aspect of Goldman Sachs’ report is that a metrics comparison between the top five companies involved in the tech bubble in 2000 and the current situation of the FAAMG stocks resulted into an advantage for the latest. The Big 5 in 2000, Microsoft, Cisco, Intel, Oracle and Lucent had an astonishing aggregate forward P/E rate of 58.3, a cash over enterprise value ratio of just 2% and a FCF yield of 1.6%. It perfectly exposes the classic recipe of a bubble. In the present, the FAAMG companies may have learned something from their predecessors (especially Microsoft) and exhibit more than healthy metrics: a forward P/E rate of 22.7 and reasonably low burning rates of cash (more for Alphabet and Microsoft, less for Facebook and Amazon).

In the long term, the tech sector is expected to continue to outperform. Companies like Apple have more than 25% of market cap in offshore cash, placing it rightfully on the first position in market value in the entire world. Google (Alphabet), Microsoft and Facebook also seem strong on their second, third and fifth positions, backed by strong fundamentals, however Amazon seems as the most likely tech giant to face a reverse of the momentum in the near future.

Written by Radu Simion