(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of GOOGL and NFLX.)
The FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) have had a strong 2017, with all of them easily outpacing the S&P 500 thus far. It should come as no surprise that they have performed so well because they are all delivering strong earnings.
Moreover, three of the five FAANG stocks are not expensive, with Apple Inc. (AAPL), Alphabet Inc. (GOOGL), and Facebook Inc. (FB) all having fairly reasonable valuations. Amazon.com Inc. (AMZN) and Netflix Inc. (NFLX) are the only question marks. But despite the question marks, the FAANG stocks are likely far from done climbing in 2017, with plenty more upside potential.
To say the FAANG stocks are having a good year is an understatement. The worst-performing stock of the group is Alphabet, the parent of Google, and that's up over 18 percent. The rest of the group is up well over 30 percent, driven by earnings and revenue that are expected to grow materially over the next couple of years.
Adjusting For Growth
These companies, when adjusted for growth on an annual basis, are not as expensive as one might think given the enormous opportunities ahead of them. Netflix, adjusted for growth, suddenly doesn't seem nearly as expensive as its PE ratio would lead you to believe, with a PEG ratio well below one.
Even without having to adjust for growth, Apple and Alphabet both have valuations that are below 20 times future earnings. Only Amazon is left with the questionable valuation, and that is primarily because Amazon is not a company that focuses on driving the bottom line, but more on top-line revenue growth.
Amazon is projected to post revenue of nearly $250 billion by 2019, almost equal to that of Apple. Amazon trades at 1.9 times future sales, while Apple currently trades at over 3.
The bottom line is that at current levels, all of the FAANG stocks seem fairly valued based on anticipated growth rates and could actually support higher valuations because of it. It would not be unreasonable to see Netflix's PEG ratio approach 0.75 over the long term if growth stays on track. But it should stay below 1 because the growth can't be sustained for an extended period of time.
Facebook could see its PEG ratio approach 1.25 to be on par with Apple, and that would not even be a stretch considering it's growing at much faster rate than Apple.
The FAANG stocks, despite their strong showing in 2017, deserve their current valuations, and you could argue that these stocks are generally not overvalued. But to maintain valuations, the companies must continue to deliver growth. If the growth rates slow, the multiples will come down, and the valuations will follow suit.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.