Over long periods, Wall Street is a wealth-building machine. But during shorter time-lines, directional movements in the stock market are unpredictable. In 2021, the major U.S. stock indexes regularly achieved new closing highs. Meanwhile, last year, they all tumbled into a bear market.
When volatility strikes on Wall Street, investors often turn to the FAANG stocks for relief.
By "FAANG," I'm referring to:
- Facebook, which is now part of Meta Platforms (META 1.54%).
- Apple (AAPL -0.57%).
- Amazon (AMZN -1.14%).
- Netflix (NFLX -0.51%).
- Google, which is now part of Alphabet (GOOGL 0.35%) (GOOG 0.37%).
Image source: Getty Images.
The reason investors flock to these stocks is simple: They're winners. They've handily outperformed the broad-based S&P 500 over the trailing-10-year period.
Additionally, the FAANG stocks are industry leaders. Amazon accounts for nearly $0.40 of every $1 spent in online retail in the United States. Meanwhile, Meta Platforms' four top-tier social media assets (Facebook, WhatsApp, Instagram, and Facebook Messenger) lured more than half the world's adult population to at least one of its sites each month during the March-ended quarter. In other words, these are highly profitable and well-respected businesses.
But not even the FAANG stocks are built equally. As we move forward into June, one FAANG stands out as a surefire buy, while another could struggle to deliver for its shareholders.
The FAANG stock that's a surefire buy in June: Alphabet
Among the five widely owned FAANGs, it's Alphabet that sits head and shoulders above its peers as the top buy in June. Alphabet is the parent of internet search engine Google, autonomous vehicle company Waymo, and streaming platform YouTube.
The biggest concern for Alphabet is that, for the time being, it lives and dies by advertising revenue. Advertising is a cyclical industry, and weakness in ad spending tends to front-run a slowdown in the U.S. and global economy. For the past couple of quarters, we've certainly observed some ad-spending weakness, which is reflected in Alphabet's operating results.
But there's another side to this story. Even though economic slowdowns and recessions are a normal part of the economic cycle, so is the fact that recessions tend to be short-lived. All 12 recessions after World War II have lasted between two and 18 months. That compares to periods of expansion, nearly all of which have gone on for multiple years. It means Alphabet is going to benefit from advertising expansion far more often than it'll be on its heels navigating a challenging environment.
Something that certainly doesn't hurt is Google's dominant market share. According to data from GlobalStats, Google commanded a 93% share of internet search in May 2023. What's more, you'd have to go back more than eight years to find the last time Google had less than a 90% share of worldwide internet search. It's crystal clear that Google is the go-to for advertisers looking to reach a broad, or perhaps targeted, audience with their message. This should give this cash cow of an operating segment ample pricing power most of the time.
But as I've pointed out in the past, most investors are buying Alphabet stock today for the growth potential in its ancillary operating segments, such as YouTube. YouTube is an ad-and-subscription-driven platform that trails only Facebook in the number of monthly active users it draws. Short-form videos, known as YouTube Shorts, have been particularly popular and offer a way for Alphabet to improve ad-pricing power over the long run.
Cloud infrastructure service segment Google Cloud is making waves, too. Tech analytics company Canalys estimates that Google Cloud accounted for 9% of cloud service infrastructure spending in the March-ended quarter. This makes it No. 3 globally, behind only Amazon Web Services (AWS) and Microsoft's Azure.
Enterprise cloud spending is still just ramping up, and the operating margins associated with cloud services should be considerably higher than the operating margins associated with advertising. In short, Google Cloud has an opportunity to become Alphabet's leading cash-flow generator by the turn of the decade.
Lastly, Alphabet is still cheap even after the rally the FAANGs have undergone in 2023. The company's Class A shares (GOOGL) can be scooped up for 20 times Wall Street's forward-year consensus earnings and less than 14 times estimated cash flow per share in 2024. Over the past five years, investors have paid an average of 25 times forward earnings and over 18 times year-end cash flow to own shares of Alphabet (GOOGL).
Image source: Getty Images.
The FAANG stock to avoid in June: Netflix
Although the FAANG stocks have been clear winners over the long term, their individual outlooks moving forward differ. The one FAANG stock worth avoiding in June is none other than streaming-service kingpin Netflix.
Just as Alphabet has its headwinds, the FAANG to avoid has its positives. For example, Netflix's innovation is on full display. Though it's long been a leader in terms of original programming, it's what the company is doing with its subscription tiers that's raising eyebrows. The introduction of a less costly, ad-supported tier roughly seven months ago has helped the company sign up nearly 5 million people. That may be a drop in the bucket relative to its 232.5 million global subscribers, but it's a big step in reaching a new audience or retaining on-the-fence subs.
We're also seeing tangible steps forward with the company's cash-flow generation. In the years leading up to 2020, Netflix was regularly burning through its cash to expand its operations into overseas markets. But in the March-ended quarter, Netflix generated $2.18 billion in cash from operations and logged over $2.12 billion in free cash flow (FCF). The company also increased its FCF guidance for the full year by $500 million to "at least $3.5 billion."
On the other hand, competition isn't going away in streaming. While Netflix is profitable and legacy media streaming segments are losing quite a bit of money, these legacy players are also enticing a large number of users to sign up.
As of the end of the most recent quarter, Disney+ from Walt Disney claimed nearly 158 million subscribers a little over three years after launch, while Paramount Global's (PARA 1.48%) Paramount+ reached the 60 million subscriber mark. Even if legacy networks aren't directly competing with Netflix on an apples-to-apples basis in every respect, these brand-name businesses are undoubtedly slowing Netflix's growth potential. Per streaming guide JustWatch.com, Netflix's share of the global streaming market has fallen from 46% to 33% since the start of 2020.
Another concern for Netflix is the company's valuation. Whereas the price-to-earnings ratio is the default method of evaluating the cheapness or priciness of a publicly traded company, the FAANGs tend to reinvest a lot of their operating cash flow back into their respective businesses. This makes the price-to-cash-flow multiple a much better measure of value for this group of five stocks.
Even with significant cash-flow expansion, investors are paying 28 times Wall Street's consensus cash flow for Netflix in 2024. While this is down significantly from the multiples seen earlier this decade, it still makes Netflix the priciest FAANG stock of the group relative to cash flow.
Finally, a possible U.S. recession could sting Netflix. Though it does have multiple lower-priced streaming tiers, it's Paramount's Pluto TV that's attracting 80 million monthly active users. Pluto TV is a free service that's supported by ads, and "free" can be an especially compelling price point during an economic downturn.
With Netflix seemingly priced for perfection, avoiding this outperformer in June seems like the right move.
