FANGs stocks soared in 2015 with the group generating an 86% return compared to the measly 1.38% gain of the S&P 500 index. The group consists of Facebook, Amazon, Netflix, and Google’s holding company, Alphabet. For advisors, the strong performance of the group raises questions about how additional gains can be achieved in 2016 and how to best manage risk associated with the stocks.
FANGs, furthermore, have been receiving substantial media coverage, so advisors should be prepared to discuss the stocks in response to client inquiries.
FANGs have been trading with dizzying valuations. Netflix has been the most stratospheric with a price-to-earnings ratio of 401.77% in early January. Valuations for other FANG members ranged from a relatively modest 26 P/E for Alphabet to a lofty 117.80 for Amazon, according to research firm and publisher Zacks. Those valuations existed even after a selloff in early January that ranged from 7.6% to 15% for FANG members.
FANG proponents typically emphasize that the growth potential for the companies is likely to support high valuations going forward. For example, Facebook is aggressively growing its revenues and earnings by increasing sales of video commercials on its social media platform. Its founder and leader, Mark Zuckerberg, furthermore, has said he wants the company to become a leading news provider and a center for virtual reality.
One risk for Facebook is the potential for its users to grow tired of using the platform for updating friends or for sharing pictures. Amazon, meanwhile, is generating rapid revenue growth as consumers increasingly turn to the web for shopping. The company is also expanding into providing web services for business.
It has a variety of high stakes programs in the works, including developing drone delivery of its packages. Streaming movie provider Netflix, meanwhile, plans to expand into other countries, which could help it continue to grow its earnings and revenues at a time when some investors are concerned that the company has already signed up most of the people in the U.S. who want to use the service.
Alphabet, for its part, has leveraged its leadership role as a web search engine to rapidly grow its advertising revenues while expanding into the mobile computing sector with its Android operating platform.
One big plus for FANG stocks is that the companies are well positioned to benefit from the strengthening finances of U.S. consumers. With the U.S. economy consistently creating new jobs, more Americans are returning to the workforce and their resulting wages are allowing them to increase their spending.
With a drastic reduction in prices for heating oil and gasoline, furthermore, Americans’ energy costs have plummeted, so many individuals are better positioned to increase their spending. Amazon, of course, could be a direct beneficiary of that trend, although Facebook and Alphabet may also benefit from an increase in advertising as retailers seek to capture larger portions of growing consumer spending.
With that in mind, the holdings may be an attractive alternative to companies in the Materials, Industrials, and Energy sectors that are suffering with declining earnings as commodity prices drop.
Yet, caution is warranted. As with any Internet-based business, FANG companies need to constantly fend off cyberattacks and defend their clients from malicious software that could poise considerable reputation risk.
One malicious software program, for example, offered to let Facebook users control the background colors of the social media website. Perhaps less threatening, but still worth considering, is the possibility that employers will increasingly block access to FANG sites and in a concern for Amazon, block the delivery of packages for employees.
Perhaps a greater risk is that portfolio managers seeking to generate competitive returns may feel pressured to concentrate their assets in FANG stocks. The problem may be particularly worrisome with portfolio managers who were under allocated to FANGs last year and are seeking to make up for underperforming by loading up on the stocks.
For advisors, therefore, scrutinizing holdings of mutual funds and separate accounts is crucial. In addition to assessing allocations to FANGS in individual portfolios, advisors should check for overlap among funds held within clients’ investment programs. Conducting such an assessment is important because the popularity of FANGs may result in the stocks appearing in multiple portfolios and cause clients’ investment programs being over allocated to the stocks.