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1 FAANG Stock to Buy and 1 to Avoid in 2021

By Sean Williams - Jan 8, 2021 at 6:06AM

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One FAANG stock has the potential to double, while the other could succumb to competitive pressures and slower growth prospects.

Who needs amusement parks when you have the stock market? Investors were taken on a roller coaster ride in 2020 due to the pandemic. After the benchmark S&P 500 lost 34% of its value in roughly a month, it spent the following nine months rocketing higher. The 16% gain the S&P 500 registered for 2020 nearly doubled its average annual return over the last 40 years. Not too bad considering all that transpired.

But there was one group of stocks that absolutely crushed the broader market in 2020, and it's been doing so on a regular basis for the past decade: the FAANG stocks.

A person using a red pen to circle stock tickers in a financial newspaper.

Image source: Getty Images.

"FAANG" and "outperformance" may as well be synonymous

By FAANG, I'm referring to:

  • Facebook ( FB -1.14% )
  • Apple ( AAPL -1.17% )
  • Amazon ( AMZN -1.38% )
  • Netflix ( NFLX -2.33% )
  • Google, a subsidiary of Alphabet ( GOOG -0.87% )( GOOGL -0.68% )

Last year, amid the most abrupt recession in decades, these well-known industry titans returned anywhere from 31% (Alphabet) to as much as 81% (Apple). Over the trailing-10-year period, the gains for FAANGs are even more impressive, with Netflix, Amazon, and Apple all up between 1,000% and 2,000%.

The reason these five stocks have been such an unstoppable force is their overwhelming market share in fast-growing industries and their constant willingness to innovate.

As an example of this dominance, Alphabet's Google has controlled between a 91% and 93% share of internet search over the trailing-12-month period. Meanwhile, Amazon was behind 38.7% of all U.S. e-commerce in 2020, according to eMarketer. That's roughly 33 percentage points higher than the next-closest competitor. There's also Facebook, which owns four of the six most-visited social platforms on the planet.

Because the FAANGs generate so much operating cash flow, they're also able to reinvest aggressively in product development and new projects. For instance, Apple is swimming in so much cash that it's reportedly working on an electric car that it plans to launch in 2024.

An Amazon fulfillment employee preparing items for shipment.

Image source: Amazon.

The one FAANG stock you should scoop up right now

But as I survey the FAANGs, one company stands out as exceptionally inexpensive, while another appears comparatively pricey.

The FAANG stock that I'd consider the strongest buy of the bunch is the aforementioned e-commerce juggernaut, Amazon.

As noted, eMarketer pegged Amazon's share of U.S. online sales at 38.7% in 2020. What's crazy is that eMarketer also projects the company will add another 100 basis points to its share in 2021. Pretty much $0.40 of every dollar spent online in the U.S. will go through Amazon.

Admittedly, the margins associated with retail are typically small. Through the first nine months of 2020, Amazon generated $160.9 billion in North American sales, not including Amazon Web Services (AWS), but yielded only $5.7 billion in operating income. Internationally, Amazon netted $355 million in operating income on $66.9 billion in revenue. 

The saving grace of its gigantic retail presence is that it's been able to sign up more than 150 million people worldwide to a Prime membership. At minimum (i.e., based on the annual price of $119), that's at least $18 billion a year in added revenue that helps the company undercut its competitors on price, and ensures that consumers remain loyal to its growing range of products and services.

But the real lure might be the company's fast-growing cloud infrastructure segment, AWS. It's grown by 29% from the prior-year period in back-to-back quarters, and is producing an annual run-rate of $46 billion in sales. More important, the margins associated with cloud services put retail margins to shame. Despite accounting for just an eighth of the company's total sales through nine months of 2020, AWS has generated $10 billion in operating income. That compares to a little over $6 billion in operating income for all of its other businesses combined.

Over the last decade, Amazon has consistently ended every year at a multiple of 23 to 37 times its operating cash flow. But thanks to AWS, Amazon's operating cash flow has a real chance to triple by 2023. If Wall Street's cash flow consensus proves accurate, Amazon would be valued at just 14 times its operating cash flow in 2023. This suggests Amazon's share price could double and still be at its median premium over the past decade. That's a bargain investors shouldn't pass up.

Two happy siblings lying on the carpet and watching TV, with their parents on the couch in the background.

Image source: Getty Images.

The FAANG stock you'd be best off avoiding

However, not all FAANG stocks are worth buying. Even though it's the top performer of the group over the past decade, the one I'd suggest avoiding at all costs is streaming content giant Netflix.

Obviously, Netflix has been doing something right. The company's aggressive overseas expansion, coupled with its early adoption of streaming and its focus on developing original shows, has helped it acquire more than 195 million global streaming paid memberships. This includes 28 million net new paid subscribers since the beginning of the year, which isn't too terribly surprising with people stuck in their homes. 

But there are two factors that continue to make me leery about Netflix as an investment.

First, the other FAANG stocks are absolute cash cows. For instance, by 2023, Facebook and Amazon are expected to be generating about $23 per share and $231 per share, respectively, in operating cash flow. Comparatively, Netflix has been spending so aggressively on international expansion and original shows that it's been enduring a net cash outflow every year. Even if Netflix manages to break this streak, it'll be substantially pricier, relative to operating cash flow, than the other four FAANGs.

Aside from valuation, there are clear concerns about increasing competition. It's not that these new suitors are necessarily threatening Netflix's slice of the pie, so much as they're likely to dramatically slow the amount of new share that Netflix will be able to secure.

Take Walt Disney ( DIS -0.67% ) as a perfect example. In just over a year following the launch of streaming service Disney+, it's picked up 86.8 million paying subscribers. In 13 months, Disney hit the high end of its subscriber forecast for 2024. Management now anticipates Disney+ will have between 230 million and 260 million worldwide subscribers by the end of 2024.

Disney happens to be the most successful recent launch, but HBO Max and other streaming services will give Netflix a run for its money in attracting new users. 

I believe we're going to see Netflix enter a more mature (i.e., slower) growth phase, which will put more traditional fundamental metrics in focus. That's not a good thing for Netflix.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$602.13 (-2.33%) $-14.34
Apple Inc. Stock Quote
Apple Inc.
$161.84 (-1.17%) $-1.92
Alphabet Inc. Stock Quote
Alphabet Inc.
$2,840.03 (-0.68%) $-19.29
The Walt Disney Company Stock Quote
The Walt Disney Company
$146.22 (-0.67%) $0.98, Inc. Stock Quote, Inc.
$3,389.79 (-1.38%) $-47.57
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
$306.84 (-1.14%) $-3.55
Alphabet Inc. Stock Quote
Alphabet Inc.
$2,850.41 (-0.87%) $-25.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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