For many investors, 2020 has tested their investing resolves like never before. The coronavirus disease 2019 (COVID-19) pandemic has whipsawed equities over a six-month span, leading to the fastest bear market decline in history, and the quickest recovery to new all-time highs on record.
This volatility is the direct result of COVID-19 being wholly unpredictable and creating chaos at the economic level. We've witnessed a record number of companies with at least $1 billion in assets file for bankruptcy in 2020, and have seen the U.S. unemployment rate surge to levels last consistently seen in the 1930s.
FAANG stocks have been virtually unstoppable this year
And yet, the FAANG stocks could seem to care less. The acronym "FAANG" refers to:
- Facebook (META 1.23%)
- Apple (AAPL 1.21%)
- Amazon (AMZN 2.14%)
- Netflix (NFLX 0.60%)
- Google, which is now a subsidiary of parent company Alphabet (GOOGL -1.30%) (GOOG -1.26%)
On a year-to-date basis, through Monday, Aug. 24, the S&P 500 had risen by a little over 6%, which is pretty impressive considering that it was down 34% on March 23. But the FAANG stocks have vastly outperformed the broader market, with year-to-date returns of:
- Facebook: 32%
- Apple: 72%
- Amazon: 79%
- Netflix: 51%
- Alphabet: 18%
My initial thought upon seeing these returns was, "Wall Street must really love the FAANG stocks." However, a deeper dive into the recently filed Form 13Fs from high-profile money managers revealed something surprising: institutional investors weren't buyers of FAANG stocks in the second quarter. Rather, they headed for the exit.
Wall Street money managers ran for the exit in Q2
A 13F is a required filing by companies and money managers with at least $100 million in assets under management. It's due to be filed with the Securities and Exchange Commission no later than 45 days after the end of a quarter. Thus, while 13Fs can be a bit outdated by the time investors get their hands on them, they can still tell an interesting story of where the smartest and most successful money managers are putting their money to work.
In the second quarter, 13F filers reduced their aggregate shares held in the FAANG stocks by following percentage amounts:
- Facebook: minus 0.17%
- Apple: minus 5.16%
- Amazon: minus 11%
- Netflix: minus 2.25%
- Alphabet: minus 2.12% (Class A shares, GOOGL), minus 2.77% (Class C shares, GOOG)
You should note that it wasn't just under-the-radar 13F filers doing the selling. There were some prominent investors and billionaires paring down their stakes in the FAANG stocks.
For example, billionaire Ole Andreas Halvorsen's Viking Global Management dumped over 267,000 shares of Amazon in Q2 (about 30% of its stake), while Jim Simons' Renaissance Technologies closed out its position entirely by selling 192,855 shares.
Meanwhile, Jeff Yass' Susquehanna International dumped over 4 million shares of Apple (80% of its stake), and Viking Global shed 2.3 million shares of Netflix. All five of the FAANG stocks had notable sellers during the second quarter.
Here's why the FAANG stocks keep heading higher
You might be wondering, if Wall Street is a net-seller of the FAANG stocks, how come these five stocks keep heading higher? The answer, I believe, lies with the unwavering support of retail investors.
Retail investors may not account for anywhere near the lion's share of trading volume in an average day, but their love of the FAANG stocks is well known. Plus, they're really all that's left to influence the FAANG stocks to this degree if Wall Street has been a net seller of the group.
One obvious reason retail investors are drawn to the FAANG stocks is their industry dominance. For instance:
- Facebook: Owns four of the seven most-visited social platforms and has over 3.1 billion family monthly active users.
- Apple: Is by far the most dominant smartphone retailer in the U.S., and one of the most-recognized brands in the world.
- Amazon: Controls an estimated 44% of all e-commerce sales in the U.S., according to analyst estimates at Bank of America/Merrill Lynch, and is a leading cloud infrastructure company.
- Netflix: According to eMarketer, approximately 77% of all U.S. streaming subscribers will view content from Netflix, making it the domestic king of streaming content.
- Alphabet: Has been responsible for between 92% and 93% of global search market share over the trailing year.
These are dominant, well-recognized brands, and it's easy for retail investors to understand how these businesses make money.
But don't overlook recency bias as yet another reason retail investors have been infatuated with FAANG stocks. Recency bias would lead us to believe that winners keep winning. In other words, if the FAANG stocks have outperformed the broader market over the past three, five, or 10 years, what's to say they don't continue to do so in 2020 and beyond? The historical outperformance of the FAANG stocks can be a big draw for retail investors.
Can the FAANG stocks head even higher?
The question we should be asking is, after vastly outperforming the broader market in 2020, can these five stocks buck negative economic trends and head even higher? To that end, I'm not so certain, at least in the near term.
For example, I firmly believe Amazon is a $5,000 stock, if not worth even more. Historically, this is a company that's been valued at between 23 and 37 times its year-end operating cash flow, but is on track to generate more than $200 per share in operating cash flow by 2023. If Amazon is simply valued at the same premium by 2023, it could become a $3 trillion company with a share price north of $6,000. It's not going to see its share price go up in a straight line by any means, but it's not as expensive as you might think.
The same might be said for Alphabet, which has been valued at between 16 and 21 times its operating cash flow over the previous six years, but is currently going for less than 12 time the $134 per share in operating cash flow Wall Street has forecast for 2023. Even a modest rebound in the economy will allow its dominant ad platform to shine.
Conversely, I'm not as certain that Apple or Netflix has much gas left in the tank. Apple's services segment only accounted for 22% of sales in its most recent quarter, yet the company is valued at an aggressive 39 times next year's consensus earnings per share. That's a steep price to pay for a company valued at between 10 and 20 times forward EPS for more than a decade.
As for Netflix, it's facing increased global streaming competition, and the company continues to burn through cash as it expands internationally.
The point being that retail investors may need to be a bit pickier about the FAANG stocks they buy moving forward.