Be Wary of FAANG Stocks

Facebook (META -4.13%) is standing trial, and the stock just had its best day in two years. But this isn't necessarily good news for Facebook -- or Google (GOOGL -1.23%) (GOOG -1.10%), or Apple (AAPL -1.22%), or many of the other biggest companies on the market today.

In this episode of Market Foolery, host Mac Greer and Motley Fool analysts David Kretzmann and Matt Argersinger talk about some of the most interesting points to come out of the Zuckerberg hearings, and what this all could mean for Facebook's near-term and long-term future. Then, the three look at the future of the FAANG group -- why the giant companies that have returned so much in the last few years are a lot riskier than they used to be, which of the five have the best shot at good returns going forward, and more.

A full transcript follows this video.

This video was recorded on April 11, 2018.

Mac Greer: It's Wednesday, April 11th. Welcome to Market Foolery! I'm Mac Greer, and joining me in studio, we have Motley Fool analysts Matt Argersinger and David Kretzmann. Guys, welcome! Guys, how are you feeling?

David Kretzmann: Feeling better than Zuck today.

Matt Argersinger: I think so, yeah.

Greer: Better than Zuck. Well, we're going to talk some Zuck. Day two of Facebook CEO Mark Zuckerberg's appearance before Congress. Guys, yesterday's testimony seemed to get pretty good reviews, so far.

Kretzmann: Yeah, the stock was up 4% or so.

Greer: Yeah, 4%. I think that was the best day for Facebook shares in two years. So, yesterday, guys, Zuckerberg accepted responsibility for Facebook's privacy breach, saying the company made a "big mistake." He also went on to say the company should have taken a "broader view of its responsibilities." And another thing he mentioned as part of his testimony, guys, is that -- at least, he suggested -- that Facebook may be considering a paid version. He said they'd always have a free version, but they could have a paid version. David Kretzmann, what's your review so far of Mr. Zuckerberg going to Washington?

Kretzmann: First, on a high-level look at this whole testimony, it's hard for me to take a lot of these senators and their questions seriously. They've really been lecturing Zuckerberg and Facebook on the importance of privacy and user data and containing that data, which is important, but on the other hand, these are the same senators who, several years ago, called Edward Snowden a traitor for exposing mass government surveillance programs on Facebook and Google and Apple and other platforms. These are also literally the same senators who, just several months ago, voted to expand the NSA's mass surveillance program. So, for them to be lecturing Facebook and Zuckerberg on privacy, to me, seems a bit of a double standard, pretty hypocritical. Shocking, I know, for politicians. 

But, beyond that, I think Zuckerberg has done a good job. He's done what he needed to do. For the most part, he's answered the questions clearly, calmly. A lot of people have looked at that clip of him eight years ago when he was interviewed by Kara Swisher and Walt Mossberg at Recode where he was sweating bullets, he was clearly nervous and uncomfortable. He's clearly gone through a lot of coaching, did a much better job, and I think the stock's performance in light of Zuckerberg's performance shows that he's done a good job.

Argersinger: Yeah, what David said. I think Zuckerberg was much more prepared than the senators were. I think that's clear. I mean, maybe he was overprepared. The reason I think Facebook's stock was up, and it's something I felt not just yesterday but the whole way through, is that I don't think there's going to be any significant effect, especially in the near term, on Facebook's business. I don't think they were any pointed questions in the direction of its ad business. In fact, many senators clearly demonstrated they really didn't even know how Facebook made money in the first place. That, to me, as an investor, you walk away and say, "OK, Facebook's business, with Alphabet controlling some 90% of the digital advertising market, that's not changing anytime soon." There was some mention of: "Are you a monopoly? Do you think you're a monopoly?" And I think his answer was, "I don't think I am."

Greer: "It doesn't feel like that." I like that.

Argersinger: He made some excuses saying, "People have more apps." Well, that's not genuine, because there's not really an alternative to Facebook. The alternative to Facebook is Instagram, which Facebook owns. But that all aside, I don't think there's going to be any impact, really, to the business model of Facebook. I think advertisers are still going to be targeting ads, I think users are still going to be using Facebook. I think the Delete Facebook campaign, if you want to call it that, is not going to gain a lot of traction. Not a lot is going to change in the near term.

Greer: I want to ask you more about that, because as I mentioned in the read, he did suggest that there could be a paid version. He said there will always be a free version, but there could be a paid premium version of Facebook. What does that look like? If that's going to work, is that going to have to be an Amazon (AMZN -2.56%) Prime, where I'm getting something that I'm not currently getting with Facebook? Because to me, it doesn't feel like you can just say, "Hey, if you really want to feel safe, pay us, and then we'll lock up all your data." I'm like, "You should have been doing that to begin with, you've got to give me something else."

Kretzmann: I think it would probably be similar to YouTube Red, where you pay a monthly subscription and you don't get ads on the content. So, in the case of Facebook, you would pay, maybe, $5 a month, you wouldn't see any advertisements as you scroll through the Feed. So, your data would essentially be locked up, contained. It wouldn't be accessible to advertisers. Maybe you throw in a few other exclusives with content or other features, but for the most part, I think it would just be an ad-free version of Facebook. It's not really consistent with Facebook's model to have all these exclusive perks in a paid version. They want the platform to be accessible and open and available to everyone. So, I would be surprised if they end up going the paid route.

Argersinger: I agree. I think if you ask most Facebook users, I think they're concerned about what happened with Cambridge Analytica and their user data being taken and used for nefarious reasons, potentially. But I think if you ask most users, they're OK with the trade-off. They're OK with all the services and network that Facebook provides, the relationships, the community, and I think they're OK with giving up a little bit of their privacy and allowing Facebook to track them in various ways on the platform. Now, some of the ways that Facebook also tracks you, maybe when you're offline or things you're doing on your phone outside of the platform, that kind of stuff maybe needs to be reined in a little bit. Granted, we know Apple does that. They say they don't really do it, but they do. Alphabet --

Greer: [laughs] Allegedly.

Argersinger: Dave, you've been on Twitter, and I think you were absolutely right -- Google, Alphabet, in ways, is a more powerful way of tracking people than Facebook is, because you do so many more things using Alphabet's platform.

Kretzmann: If you think about it, Facebook and WhatsApp and Instagram and Messenger, those are literally just apps or a website. Google has the operating system with Android, they have the web browser with Chrome, they have the search engine, they have YouTube, they have Google Maps. Google tracks so much more user data. And some might say that the data that you share or the content you share on Facebook might be a little bit more intimate or personal, but I would argue that if you find someone's search history, browser history, video history, where they've been with Google Maps, that you're going to learn a lot more about that person than what they share on Facebook. 

So, I think Google probably has more to lose if they do have some sort of breach, because I think a lot of the questions that have been directed at Facebook, you take a step back and you realize, this is an app that you can easily uninstall. Your life isn't going to be significantly worse if you're not on Facebook. Google, on the other hand, they're entrenched in so many different areas of people's lives. Even if you're an Apple user, you're probably still using Google Search or Google Maps. So, I think Google has more to lose if Congress takes a more scrutinous look at them, similar to what they've done with Facebook lately.

Argersinger: Now, I did have one takeaway from the hearing that was interesting that I think might come back to haunt Facebook. It was in a question, if I had this right, I think Senator John Cornyn from Texas, he asked, is Facebook responsible for the content on its platform? And Zuckerberg was pretty quick to say yes. And I was like, that's interesting. If you ask me, I think what Congress cares about is not necessarily how much money or how Facebook makes its money. It's really concerned about the influence that the platform can have. And I think there's always been this tension, and there will always be this tension, between free speech and hate speech and what's considered news and opinion versus fake news and lies, and things like that. And we've seen Facebook be truly, hugely influential in that. 

So, Facebook's admission from Zuckerberg that they're responsible for that content makes me think: You know what? Then you're also, maybe, a publisher. You're not just an advertiser, you're not just a consolidator of free content. You're actually using and selling that content, potentially. So, that opens you up to a lot more scrutiny in terms of liability and being sued and how information is used for nefarious reasons. That, to me, was a little bit of an added risk. I feel like now, if I read Facebook's 10-K next year, there's going to be a whole new section about, "Here's our content risk factors."

Greer: That was a fascinating exchange, this idea with Cornyn, is Facebook ultimately an agnostic tech platform, or is it a media company with a somewhat distinct point of view? And if it's a media company, to your point, Matt, it opens itself up to all sorts of new regulation. And it seems kind of like this hybrid. It's kind of a bit of both. You don't have people writing for Facebook, per say. But, it also has influence on the political scene.

Argersinger: Zuckerberg has talked about this before. They want to have 20,000 people going along the platform for security reasons. When is it going to be at a point where they restrict some users or some media thing's content and incense: "You're restricting our free speech. Are you doing this because we're a conservative news outfit/a liberal news outfit, and you think our speech is extreme, even though it's not?" You get into very muddy waters when you start doing that.

Kretzmann: That also really boils over to YouTube, as well, because YouTube has gone through similar issues, where you have certain content creators basically saying, "You're essentially censoring our videos," or "The algorithm isn't pushing our videos like it is with other content creators," or "We're not able to monetize our videos, you're not letting us show ads on our videos." So, this question of, are you a tech platform, or are you a media company with the accompanying responsibilities? That's something that Facebook is sort of addressing in a weird, blurry, gray-area way. But, that's also something that YouTube and Google will probably have to address.

Greer: As we wrap this up, we've talked about Google and YouTube throughout this conversation. If, if, if -- and, this is a big if -- if a substantial number of people say, "I don't quite trust Facebook the way I used to, and I'm leaving, and I'm not going to Instagram," so, they're not going to another Facebook property, is there another company that stands to benefit? Or, do you just look at this as Facebook's loss is really no one's gain?

Argersinger: Twitter. Come on, people!

Kretzmann: [laughs] There you go.

Argersinger: No, I don't know. To Facebook's credit, if you're an American and you're looking for social networks, and in Europe, too, there really is no Pepsi right now to Facebook's Coke. The power of a social network is the network, it's the network effect, it's the size of the network, it's where all my friends are and the things that I care about and the things I like to do, it's all there. And people are going to seek that out, but where do they seek that out if they don't go to Facebook? I don't use Facebook, just because I haven't from the beginning. But if you've used Facebook for years, and your entire history and all your family and friends and relationships are all on there, to me, it's hard to see where someone is going to go.

Kretzmann: Yeah. It demonstrates the power of the network effect. Really, unless your whole group of friends are all leaving Facebook and adopting the same other platform, you really don't have a whole lot to gain by leaving Facebook and joining another platform, like Snap, which, Snap has a completely different use case and tends to target a younger audience. 

Really quick, before we wrap up, something else that's really been interesting throughout this whole debacle is Facebook's comments on, "We actually welcome some regulation here." I thought there was an interesting and actually smart exchange yesterday, where one of the senators was saying, the fact that you're asking for regulation, regulation could actually help Facebook by limiting the access of upstarts or smaller companies to Facebook's data, or potentially make it a lot more expensive to be legally compliant as far as privacy standards and things like that. That brings up the question, if there are legal next steps, what regulations could actually be put in that hurt Facebook and help other competitors? I don't know if you could actually get to that point, because Facebook has plenty of cash, they can easily adopt any regulatory standards that come up, like, recently in the E.U. So, then, perhaps we'll see more people call for Facebook to be broken up, split up Facebook, split up Instagram. I think that's actually solving what people want to be solved more than regulation would do.

Argersinger: And I'll just add one final takeaway, as well. I feel like maybe I'm burying the lede here or something, but, I do think we're probably on a three-, maybe four-year clock on Zuckerberg's time as CEO of Facebook. I just think, looking at him -- and he did great, I think, for the most part, in facing Congress -- but, I don't think this is a job he likes.

Greer: Really, though? I think it's his mission. I think he's a lifer. I'm going to take the other side of that.

Argersinger: Yeah? Well, I just think it's not his personality. I don't think he wants to be a public face of anything, really, let alone this massive, multi-hundred-billion-dollar company that he's created. I think he'd be more comfortable stepping back in a chairman role, the same way Bill Gates did in his 40s, and say, "I'm going to step back, take more of a broad, creative view of the company, maybe focus a little more on philanthropy and things like that, and let Sheryl Sandberg or someone else take the CEO's job." I just got that feeling, and I think that's closer than we might think it is.

Greer: Guys, as we wrap up here, I want to pivot to a broader discussion about the so-called FAANG stocks -- Facebook, Amazon, Apple, Netflix (NFLX -9.09%), Google/Alphabet. Now, we've obviously talked a lot about Facebook. I want to get your thoughts. When you look at these other stocks, who do you think is best positioned over the next, let's say, five years? And who do you think could have Facebook-type problems, be it with privacy, be it with regulators and the like?

Kretzmann: I think Netflix is probably best positioned over the next five years. Historically, when you look at the five or ten biggest companies in the U.S., they actually don't have that great of a track record. If you go back to 1995, the five biggest companies: General Electric, AT&T, ExxonMobil, Coca-Cola and Merck. None of those are in the top five anymore, obviously. Now, you could argue that having a tech- or internet-based platform that allows you to scale a lot more efficiently, you have network effect, so maybe more of the FAANG is here to stay, and they'll continue to be the dominant companies five and ten years from now. But, just looking at the historical precedent, you probably wouldn't bet on those companies. Usually, there are some newcomers that do end up becoming large. 

Netflix has that advantage. It's about a $130 billion company, still in the early innings as far as the international expansion. They have well over 100 million global subscribers now, but I think over the next five years, they'll hit 200 and 300 million. And even then, more people around the world are getting access to broadband and more people want content, so with Netflix, you have a growing addressable market, and the growth story is still in those early stages. And, I don't think they have near the level of regulatory scrutiny that the other four FAANG stocks have.

Argersinger: Yeah, I like that a lot. If you're saying, which is going to face the least amount of scrutiny, it's certainly Netflix. Their business is about entertaining people, and people are comfortable with the platform. It's not this company that has so many tentacles in all these other places. Me, personally, I just think Amazon has so much upside to go. I know it draws the ire of our dear president for various reasons we don't have to get into. But, I just think, you look at the percentage of their retail sales in the United States, it's about 4%, it's like a third of what Walmart has. And the things that Amazon is doing with Prime and digital streaming and Amazon Web Services, it's easily going to be a much, much larger company, if it's allowed to be a much larger company.

And that's the rub. That is the rub. And I think David's point is great. If you go back in history, generally, if you look at any given era, the five largest companies, you didn't do well as an investor investing in those five. You're better off looking at smaller companies. And if you look at the FAANG stocks -- this is incredible -- over the past five years, the average return for the FAANG stocks is 500%.

If you go back to three years, when, I think, the term was coined, "FAANG stocks," they're up 200%. So, even after they became a thing, if you bought them, you're up 200% in three years. It's just remarkable. And, as an investor, you have to look back and say, "Can this possibly continue?" Especially now with, finally, regulation trying to catch up a little bit to these platforms, and people being more educated about just how much influence they have and could have in the future. I think there's a lot of risk to buying these companies today.

Greer: But it sounds like you're Team Amazon, if push comes to shove?

Argersinger: I am Team Amazon, all the way.

Greer: David, I want to push back a bit on Netflix. And we'll get back to Amazon here. I noticed that you did not mention, there's an upstart by the name of Disney that is starting to get into streaming more.

Argersinger: Small, feisty company.

Greer: Small, feisty, scrappy. There's this mouse that you may have seen.

Kretzmann: The Hidden Gem, yeah, that's right.

Greer: So, how does that figure into your long-term thinking about Netflix?

Kretzmann: I don't think it's a zero-sum or winner-take-all game. Already, you have people who subscribe to Netflix, HBO, Hulu, Amazon, so I don't think there's necessarily going to be one go-to content creator. But, in the case of Netflix, I think they do have a powerful first-mover advantage. They have a data advantage. They've been doing online streaming for over ten years now, so they have so much data as far as user consumption, viewing habits, what types of content people like at certain times of the day, certain parts of the world. I think it's going to take time for Disney to catch up. I think Disney will do well, but I don't see Disney being a Netflix killer or a Netflix displacement. I think of anything, it'll be complementary.

Greer: OK, so there's room for both. Matt, I want to ask my tough question about Amazon. You mentioned earlier that you thought Zuckerberg, in terms of the CEO position, may not be long for this world with Facebook. If Jeff Bezos leaves the CEO position in the next five years, does that change your thinking on Amazon?

Argersinger: If he left in five years ... well, I don't think he'll ever leave, but if he gave up that role and went back to something else in five years, I wouldn't be too worried. If he left today, I would be absolutely worried.

Greer: He's a big space guy. What if he says: "You know what? I'm going to take my money and I'm going to Mars"?

Argersinger: I don't know. I just think, for some reason, I see Jeff Bezos in the CEO spot until he's 80 with Amazon. I don't know why. I just don't see that with Zuckerberg the same way, or in a lot of companies. But I think Jeff Bezos is just, I mean, the guy started this company in a small room as an online bookseller, and he had the same vision 25 years ago as he has still today. So, I don't think he's ever going to let go.

Kretzmann: And, you had a second part of that question along the lines of, which of those FAANG stocks has the most downside or the most to lose from a regulatory standpoint. I already mentioned at the top of the show, but I think Google has already demonstrated that it is in the sniper line of fire so far, already that $2.7 billion fine from the E.U. about a year ago. I think Google would have a lot harder time answering the questions that the senators and congresspeople have been throwing at Zuckerberg and Facebook. If Google ever did get to that point where you bring the CEO, you bring the chairman there, I think they have a lot harder time answering those questions about privacy and user data.

Greer: We will keep an eye on it. Matt and David, thanks for joining me!

Kretzmann: Thanks, Mac!

Argersinger: Thanks, Mac!

Greer: As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! We'll see you tomorrow!