Facebook (FB 0.71%) and Google parent Alphabet (GOOGL -1.38%)(GOOG -1.48%) were the two worst-performing FAANG stocks in 2020, trailing far behind Apple (AAPL -1.07%), Amazon (AMZN -1.98%), and Netflix (NFLX -0.60%) during the onset of the COVID-19 pandemic.
Between Facebook and Alphabet's reliance on advertising (which tends to take a hit during a recession) and regulatory concerns (both are facing lawsuits and possible break-ups of their businesses), this underperformance makes sense. However, both companies are flush with cash and could be in line for a big rebound as digital advertising continues to take over traditional ads. Which is the better buy?
Facebook: The social media titan under fire
The social media empire in charge of Facebook, Instagram, and WhatsApp has been at the center of controversy for years now. That likely isn't going to end anytime soon as the Federal Trade Commission (FTC) has sued Facebook for anti-competitive behavior. If the FTC has its way, Facebook would be forced to separate from Instagram and WhatsApp, which it purchased in 2012 and 2014, respectively.
I'm not convinced this would be an endgame for Facebook. After all, it would likely end up with cash proceeds from the sale or spin-off of either of those businesses. But in the meantime, the social media leader is more than holding its own during the pandemic. Though ad sales took a hit last spring, they quickly rallied as small businesses are increasingly relying on the platform to reach their customers.
Specifically, revenue increased 22% year-over-year during the third quarter, jumping from the only 11% year-over-year gain notched in the second quarter. Through the first nine months of the year, total revenue was nearly 17% higher compared to the same period in 2019. And in spite of ongoing expenses to update its privacy controls and comply with other regulator requests, free cash flow (revenue minus cash operating expenses and capital expenditures) was $13.8 billion on revenue of $57.9 billion -- good for a free cash flow margin of 24%.
Facebook also had $55.6 billion in cash and marketable securities on hand at the end of September with zero debt. If it has to sell off Instagram, WhatsApp, or both, its war chest would likely only get larger, a powerful tool the company would be able to deploy to help support its Oculus virtual reality business -- or other aspirations like in the digital payments space. For now, 99% of Facebook is advertising, but the company could be so much more in another decade's time.
Google: Search is the core but not the only game
Google has had its own woes, getting handed an antitrust lawsuit from the Department of Justice (DOJ) claiming it has been anti-competitive in its strategies to protect its internet search and ad business from competitors. The case won't go to trial until 2023, though, and in the meantime Google should be able to further diversify away from its digital ad roots.
It's already well on its way to doing so. Advertising made up 80% of total revenue in the third quarter, but Google Cloud is making great headway. Sales within that segment increased 45% year over year to $3.4 billion (7.5% of revenue). Google Other, which includes app store sales, subscriptions via YouTube, and hardware like the Pixel device lineup, grew 35% to $5.5 billion (12% of revenue). Then, there's the moonshot portfolio of loss-generating but potentially game-changing start-ups like Waymo for self-driving cars and Verily in the life sciences space. Google is funneling large sums of cash into these businesses to grow them at a rapid pace.
Speaking of cash, Google really does have a ton of it. Even after supporting its high-growth endeavors, the company generated free cash flow of $25.6 billion through the first nine months of 2020 on revenue of $125.6 billion -- a free cash flow profit margin of 20%. And that's during a period in which Google advertising notched its first quarterly year-over-year decline since the financial crisis of 2008 and 2009. As effects of the pandemic slowly ease and marketing activity continues to go digital, Google could also be in line for a big 2021 just like Facebook.
Also like Facebook, investors might be worried about regulatory action against the internet giant. But with cash and marketable securities of nearly $132.6 billion, offset by total debt of only $13.9 billion, this is hands-down one of the deepest pocketed organizations in the world. Already well on its way to being more than a one-trick pony, I wouldn't bet against Google over the long term.
Which is the better buy?
Facebook and Google, along with big tech in general, are both facing stiffer regulatory actions in the years ahead, but neither company is going to be easily overthrown. While I own shares of both, if I had to choose just one, I'd go with Google.
Both stocks trade for a premium in the range of 4 times trailing 12-month free cash flow, but I think Google could be in store for a bigger rebound in its ad business in the next year or so. It's also better diversified, and its other high-growth businesses like Google Cloud could start paying off in a big way as they reach profitable scale. Plus, there's something to be said about having a mountain of cash like Google's. After underperforming its big-tech peers in 2020, Alphabet stock gets my nod as the best FAANG stock for 2021.