From time to time, Wall Street sends investors a not-so-subtle reminder that while the stock market tends to move higher over long periods, it doesn't take a straight-line path. Last year, all three major U.S. stock indexes were thrust into a bear market, with the widely followed S&P 500 and tech-driven Nasdaq Composite ending the year down 19% and 33%, respectively.
Historically, when the going gets rough for Wall Street, investors turn their attention to tried-and-true industry leaders, such as the FAANG stocks. When I say "FAANG," I'm referring to:
- Facebook, which is a subsidiary of Meta Platforms (META +0.58%).
- Amazon (AMZN 1.40%).
- Apple (AAPL 0.04%).
- Netflix (NFLX +0.02%).
- Google, which is a subsidiary of Alphabet (GOOGL 0.04%)(GOOG +0.04%).
Image source: Getty Images.
These are well-loved stocks because these companies offer well-defined competitive advantages. Netflix is the streaming market-share leader; Amazon is the dominant player in e-commerce; Meta's social media sites are tops globally; Apple's iPhone is the clear-cut U.S. smartphone share leader; and Alphabet's Google accounts for the lion's share of global internet search. People invest in these businesses because of their perceived moats and (often) exceptional cash-flow generation.
But not even the FAANG stocks are created equally. As we push ahead into the new year, two FAANG stocks can be confidently bought hand over fist, while another member of the group is best avoided.
FAANG stock No. 1 to buy hand over fist in 2023: Meta Platforms
The first FAANG stock that's a screaming buy in 2023 is social media giant Meta Platforms.
Meta had a horrendous year, with a slowdown in ad spending and higher costs associated with metaverse division Reality Labs significantly reducing its free cash flow and earnings, as well as reversing its previously unstoppable, double-digit revenue growth. Even though near-term economic uncertainty could continue to weigh on ad spending in the early part of 2023, the necessary puzzle pieces are in place for Meta to find solid ground and begin delivering for its shareholders, once again.
NASDAQ: META
Key Data Points
Despite the company shifting a lot of its spending to various metaverse initiatives, investors would be wise not to overlook how dominant Meta remains within social media. Facebook is the most-visited site globally, with around 2.9 billion monthly active users. When other owned assets, such as WhatsApp and Instagram, are added, Meta manages to bring in approximately 3.7 billion unique monthly active users (MAUs).
While aggregate MAU growth has understandably slowed, advertisers realize that there isn't a social media platform in the world that offers more eyeballs than Meta's top-tier assets. Not surprisingly, the company has been able to command strong ad-pricing power during long-winded periods of economic expansion.
As I've pointed out previously, CEO Mark Zuckerberg's aggressive spending on the metaverse is something his company can withstand. Meta closed out September with $31.9 billion in net cash, cash equivalents, and marketable securities, and its advertising business, which accounts for over 98% of total revenue, remains very profitable. If the metaverse turns out to be the multitrillion-dollar opportunity it's been advertised as, Meta should become one of the key on-ramps to this massive ecosystem.
Over the past five years, Meta has traded at an average multiple to its cash flow of 17. But if Meta can meet Wall Street's consensus cash-flow estimates for 2024, investors can buy in now for a cash-flow multiple of less than 6. That's an incredible bargain opportunistic investors shouldn't pass up.
NASDAQ: GOOGL
Key Data Points
FAANG stock No. 2 to buy hand over fist in 2023: Alphabet
The second FAANG stock that can be bought hand over fist in the new year is Alphabet, the company behind Google, streaming platform YouTube, and autonomous vehicle company Waymo, among other subsidiaries.
Alphabet and Meta are facing pretty much the same macroeconomic headwind at the moment: weaker ad spending. Since the vast majority of Alphabet's revenue comes from advertising via Google and YouTube, the prospect of economic weakness has prompted advertisers to reduce their spending. While this short-term maelstrom has been unpleasant, it'll have no bearing on Alphabet's long-term growth strategy.
To begin with, internet search engine Google might as well be considered a monopoly. Based on data from GlobalStats, it's accounted for no less than 91% of worldwide internet search share dating back to the beginning of 2020. Similar to how advertisers view Meta's social media assets as the logical choice to get their message in front of as many users as possible, Google is the logical choice for advertisers wanting to target their message via internet search. This distinction is what should afford Google exceptional ad-pricing power more often than not.
But the real intrigue is what Alphabet is doing beyond Google. With YouTube, the second most-visited social site in the world behind only Facebook, Alphabet is looking for ways to better monetize YouTube Shorts (videos of less than 60 seconds), which have been attracting approximately 1.5 billion viewers each month.
There's also cloud-infrastructure service Google Cloud, which according to Canalys worked its way up to a 9% global share of cloud-infrastructure spending in the third quarter. We're likely seeing just the tip of the iceberg when it comes to enterprise cloud spending, which is why Google Cloud has been able to sustain revenue growth in the neighborhood of 40%. This is a potentially high-margin segment that could become a serious cash-flow driver for the company by mid-decade.
Yet the jaw-dropper is Alphabet's valuation. It's sitting on more than $101 billion in net cash, cash equivalents, and marketable securities, yet can be purchased by investors for a little over 9 times Wall Street's forecast cash flow for 2024. That's close to a 50% discount to the cash-flow multiple investors have been paying for Alphabet stock over the past five years.
Image source: Getty Images.
The FAANG stock to avoid like the plague in 2023: Netflix
On the other side of the aisle, streaming service Netflix stands out as the black sheep of the bunch that should be actively avoided in 2023.
To be fair, Netflix has clearly done certain things right; otherwise, it wouldn't have a $131 billion market cap and be the global and domestic leader in streaming-service share. Netflix has benefited from its first-mover advantage, as well as its veritable mountain of original programming, which draws new subscribers in and keeps existing subscribers from leaving.
Furthermore, Netflix is profitable on a recurring basis at a time when virtually every other streaming service is bleeding. In other words, Netflix has demonstrated that its operating model works. With the recent addition of an ad-supported tier, the expectation is for the company to continue building on its more than 223 million global subscribers.
NASDAQ: NFLX
Key Data Points
However, Netflix's subscriber growth has slowed dramatically as competing streaming platforms have ramped up. It took Walt Disney less than three years to get the subscriber count for Disney+ to more than 164 million. Likewise, Paramount Global's Paramount+ and Warner Bros. Discovery's streaming offerings (HBO Max and Discovery+) have produced sustained double-digit subsriber increases. Despite near-term losses, these companies are well known and have deep pockets. In short, they can continue to constrain Netflix's subscriber growth.
Another really big problem for Netflix is its cash-flow generation. Similar to how Walt Disney, Paramount, and Warner Bros. Discovery have opened the proverbial spigot to spend on international streaming expansion, Netflix spent a small fortune bolstering its overseas presence. Unfortunately, spending big to acquire and produce content has resulted in minimal cash-flow production.
Whereas Meta Platforms and Alphabet can be purchased by investors at historically low multiples to future cash flow, Netflix is currently valued at nearly 26 times Wall Street's forecast cash flow for the company in 2024 and more than 40 times what's expected this year. Though we've heard management talk about improving the company's cash flow, we've yet to really see it materialize. Until that happens, Netflix is a FAANG stock worth avoiding.
