The story for much of the past decade has been one of outperformance. Following a steep descent during the Great Recession, the stock market came back with a vengeance throughout the 2010s. The benchmark S&P 500 has gained 191% during the decade, through this past weekend. On a historical basis, that's nearly double the annualized average return of the market (including dividend reinvestment and adjusting for inflation).
Yet, one special group performed even better over the past decade: the so-called FAANG stocks.
FAANG stocks have run circles around the broader market
FAANG is an acronym for the collective of:
- Facebook (NASDAQ:FB)
- Amazon (NASDAQ:AMZN)
- Apple (NASDAQ:AAPL)
- Netflix (NASDAQ:NFLX)
- Google, which is now a subsidiary of Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL)
If you bought into the FAANG stocks at the closing bell on Dec. 31, 2009, you'd be up by the following today (including dividends for Apple and, in Facebook's case, based on its closing price following its IPO):
- Facebook: Up 444%
- Amazon: Up 1,290%
- Apple: Up 1,007%
- Netflix: Up 4,082%
- Alphabet: Up 345%
Not too shabby! An equal investment in each of the FAANG stocks would have resulted in an average return of 1,433% during the 2010s, or more than six times that of the benchmark S&P 500. This is why investors continually flock to these dominant companies.
The question is: Which FAANG stocks look poised to add to their gains in 2020 or potentially retrace? With this in mind, let's look at the no-brainer FAANG stock that appears to be buy-worthy this year, as well as the one you'd be best off avoiding.
The one FAANG stock you'll want to own in 2020
When looking at traditionally high-growth companies, such as those found in the FAANG group, valuations metrics like the price-to-earnings ratio don't tell the full story. Rather, I'm a big fan of factoring in future growth prospects, which is why I believe the price-earnings-to-growth ratio (PEG ratio) is a considerably better indicator of value among FAANG stocks. And right now, there's a clear leader in my eyes: Amazon.
Over the trailing five-year period, Amazon's PEG ratio has often been well north of 2, which signifies a fully valued or aggressively priced stock. But Amazon's current PEG ratio of 1.2 actually suggests it's approaching value territory (a PEG below 1 would signal an undervalued company).
Furthermore, Amazon is set to see its cash flow explode over the next three years. After being valued at an average of 30 times its cash flow over the past five years, Amazon will end 2019 at roughly 20 times Wall Street's estimated 2020 cash flow per share, and a mere 11 times 2022's estimated cash flow per share.
Dare I say it? Amazon is a borderline value stock!
Interestingly enough, it's not the company's e-commerce segment that'll be doing the heavy lifting. Although Prime memberships have proved important in keeping consumers loyal, retail is a generally low-margin business. Instead, Amazon Web Services (AWS) is the business driving this company's long-term growth. AWS' cloud services are growing much faster than its e-commerce operations, and they're already generating more operating income, despite the fact that AWS sales have accounted for "only" $25.1 billion of the $193.1 billion in net sales through the first nine months of 2019.
After lagging the benchmark in 2019, I'm looking for Amazon to handily outpace the S&P 500's 2020 return.
This FAANG stock could have a rough year
On the other hand, I'm not a big fan of streaming giant Netflix this year, and I believe it could get trampled by the broader market.
Using the same metrics I used for Amazon, Netflix has a considerably loftier PEG ratio of 2.27, implying that it's fairly valued, if not a bit pricey. Although this is considerably lower than its five-year average PEG of more than 4, it's still not indicative of an enticing value.
Additionally, Netflix is the only FAANG stock that currently has an annual net-cash outflow. The streaming giant is sparing no expense in its efforts to move into international markets. As a result, all operating cash flow, plus some of the company's existing cash, is being funneled into this expansion effort. It could be years before Netflix generates positive operating cash flow.
But the big concern is the flurry of new competition in the streaming space from Walt Disney, Comcast, AT&T, and Apple, and existing players such as Amazon. Even though Netflix's management isn't concerned about this new competition, there's liable to be some amount of domestic attrition, which I find worrisome for two reasons.
First, U.S. streaming margins were double that of its international operations in the most recent quarter. This means if Netflix experiences a slowdown in U.S. subscriber growth, it'll really be felt in its bottom line. Second, as streaming competition has ramped up, I find it to be no coincidence that Netflix's actual paid subscriptions have missed its own estimates for the past two quarters.
While Netflix has shown itself to be the king of the streaming crowd for now, the signals appear to say the company will have a subpar 2020.