It's been a wild four years for Wall Street and investors. Since the green flag waved in January 2020, the three major stock indexes -- the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite -- have teetered back and forth between bear and bull markets in successive years. It's a solid reminder of just how unpredictable the stock market can be over short time frames.
When volatility picks up is precisely when investors usually seek out the safety of time-tested, industry-leading outperformers. In other words, it's precisely why the FAANG stocks have crushed the broader market over the trailing decade.
Image source: Getty Images.
The FAANG stocks bring well-defined competitive advantages to the table
When I say "FAANG stocks," I'm talking about:
- Facebook, which is now a subsidiary of Meta Platforms (META +0.74%)
- Apple (AAPL 0.49%)
- Amazon (AMZN +0.61%)
- Netflix (NFLX +0.13%)
- Google, which is now a subsidiary of Alphabet (GOOGL +1.28%)(GOOG +1.09%)
What these five companies offer investors is seemingly insurmountable competitive advantages.
- Meta Platforms is the parent behind the world's top social media assets. Collectively, Facebook, WhatsApp, Instagram, and Facebook Messenger are four of the most downloaded apps globally and were responsible for luring nearly 4 billion monthly active users during the December-ended quarter.
- Apple has been a dominant domestic player in the smartphone arena since introducing the iPhone. It's also in the process of transforming itself into a services-focused company. The icing on the cake is that Apple's share repurchase program is unrivaled -- over $600 billion worth of buybacks since initiating a repurchase program in 2013.
- Amazon's e-commerce marketplace brought in nearly $0.40 of every $1 in U.S. online retail sales in 2022, according to an estimate from Insider Intelligence. Further, Amazon Web Services (AWS) is the world's leading provider of cloud infrastructure services, with an estimated 31% share, per tech-analysis firm Canalys.
- Netflix is the domestic and international streaming share leader. Additionally, no streaming service has come remotely close to its expansive library of original content.
- Alphabet's Google was responsible for 91.5% of global internet search share in January. It's also the parent of streaming service YouTube, the second-most-visited social site behind Facebook; and Google Cloud, the No. 3 cloud infrastructure service provider worldwide by market share.
Despite these well-defined competitive edges, the outlook for each FAANG stock differs greatly. In February, one historically inexpensive FAANG stock stands head and shoulders above its peers as a phenomenal buy, while another highflier is set to face a mountain of potential headwinds.
NASDAQ: GOOGL
Key Data Points
The FAANG stock to buy hand over fist in February: Alphabet
Out of the five longtime outperformers listed above, it's Google, YouTube, Google Cloud, and Waymo parent Alphabet that stands out as the smartest buy in the shortest month of the year.
To be fair, even the best stocks that look like no-brainer buys face potential headwinds. For Alphabet, the biggest concern is the likelihood that the U.S. will fall into a recession at some point this year. The Federal Reserve Bank of New York's leading recession probability indicator, along with an assortment of money-based metrics, suggest that a downturn is likely. Since Alphabet generates a majority of its revenue from advertising, the expectation would be for a slowdown in its growth and profits if a recession materializes.
However, there are two sides to this coin -- and it most definitely favors investors who are patient. Even though recessions are a normal, inevitable part of the economic cycle, only three of the 12 downturns that have occurred since the end of World War II lasted 12 months. By comparison, almost every economic expansion since September 1945 has endured for multiple years. Ad-driven businesses with sustainable competitive advantages are perfectly positioned to thrive over long periods.
Google's absolutely dominant position as the world's leading search engine isn't going to change anytime soon. It's been almost nine years since Google last held less than a 90% monthly share of worldwide search, based on data from GlobalStats. This suggests it'll have little issue maintaining exceptional pricing power and increasing its operating cash flow over time.
But most investors (including myself) are more excited about what Alphabet's ancillary operating segments have to offer. For instance, daily views of YouTube Shorts (short-form videos typically lasting less than a minute) have grown by more than a factor of eight since 2021. This should help YouTube's ad-pricing power and encourage users to sign up for high-margin subscriptions.
Perhaps even more exciting is Alphabet's rapidly growing cloud segment. Following years of operating losses, Google Cloud delivered four consecutive quarters of operating profit in 2023. Not only is enterprise cloud spending still in its early innings, but the margins associated with cloud services are usually considerably higher than those associated with advertising. As Google Cloud grows into a larger share of net sales, expect Alphabet's operating cash flow to expand even faster.
Lastly, Alphabet is cheap. Its forward-year earnings multiple of 19 is lower than the benchmark S&P 500, while its multiple of 13.4x consensus cash flow in 2025 is roughly 26% below its average cash-flow multiple over the trailing five years.
Image source: Getty Images.
The FAANG stock worth avoiding in February: Netflix
Although the FAANG stocks have been virtually unstoppable for more than a decade, not all five components are worth buying. In February, the highflier worth avoiding is none other than streaming service Netflix.
Just as Alphabet has headwinds as a stock to buy, Netflix has possible catalysts as a stock I'd suggest avoiding. The single biggest driver for Netflix is that its vast content library affords it substantial subscription pricing power. Historically, Netflix has lost very few customers when it's raised its monthly subscription prices. It also doesn't hurt that the company is offering more streaming options than ever, including the addition of an ad-supported tier.
Additionally, Netflix's cash flow needle is moving in the right direction. Netflix generated $6.9 billion in free cash flow (FCF) last year, more than quadrupling the $1.6 billion in FCF from 2022. Significant growth in cash flow has allowed Netflix to aggressively repurchase its stock -- 5.5 million shares bought back during the fourth quarter for roughly $2.5 billion. A reduced outstanding share count for steadily profitable companies can provide a lift to earnings per share (EPS).
Unfortunately, it's not all good news for Netflix.
NASDAQ: NFLX
Key Data Points
The obvious issue is that competition for streaming services has been heating up. Walt Disney, Paramount Global, and Warner Bros. Discovery have all quickly grown their respective subscriber bases. These are brand-name media companies that have traditionally had profitable legacy TV segments. In other words, they have plenty of capital to endure temporary losses as they build out their streaming segments.
However, streaming losses for Netflix's competitors may not continue much longer. Disney anticipates its streaming segment will turn the corner to recurring profitability by the end of its current fiscal year (i.e., by the end of September 2024). Meanwhile, Paramount and Warner Bros. Discovery should see notably smaller losses from streaming in the new year as advertising revenue perks up, cost-cutting takes shape, and subscription prices increase.
Another reason to cast doubt on Netflix is the company's decision to approve a sizable $10 billion share repurchase program in October. Though buybacks are shareholder-friendly, large repurchase programs are typically reserved for mature businesses or those running out of innovative ideas. An acceleration of buybacks could signal that Netflix is struggling to find new and innovative ways to move the needle, which would be particularly worrisome given its valuation.
Lastly, there's the company's premium valuation. Shares of Netflix are currently priced at approximately 27x forward-year earnings and 26x forward-year cash flow. It's the priciest FAANG stock relative to cash flow, which makes it an easy stock to avoid for the foreseeable future.
