It is another FANG-focused day. Or is it FAAMG? I get confused sometimes. FANG is short for Facebook Inc. (FB), Amazon.com (AMZN), Netflix Inc. (NFLX), and Google, whose parent is Alphabet Inc. (GOOGL). FANG is comprised of four high-performing technology stocks of 2017.

Similarly, FAAMG is the acronym for Facebook, Amazon, Apple Inc. (AAPL), Microsoft (MSFT) and Google. You get the picture. There is no doubt these are some of the best-performing stocks of 2017, but surely the constant attention on them is just too much sometimes.

On Thursday, Canaccord analyst Michael Graham fired a shot across the bow of FANG, downgrading Alphabet to hold from buy, but reiterated his price target at $1,000. As for the rest of FANG, the analyst noted a lot of the good news is already baked into the share prices. The FANG quartet is trading lower by 1.5 percent.  

FB Chart

FB data by YCharts

Is FANG overvalued? That's tough to say for so many reasons. We have a couple of things to contend with, the first being a slow growth environment. Companies that can offer potentially strong growth get a premium valuation. Second, the companies are being priced off future expectations, and the analyst community has been setting those expectations relatively high based on current estimates. Finally, what is the correct historical valuation for a company that is going through multiple growth phases? 

This chart shows you the trailing 12-month revenue for each company in the FANG group overlaid with the annual revenue estimates going out to 2019.

FB Annual Revenue Estimates Chart

FB Annual Revenue Estimates data by YCharts

We can see here that revenue growth for Amazon has been gigantic over the past decade. The same is true for Alphabet, with Facebook ramping, and Netflix just really starting to kick into gear. The chart below shows the expected revenue growth from the end of 2016 until the end of 2019 for each company. 

FB Annual Revenue Estimates Chart

FB Annual Revenue Estimates data by YCharts

So we have monster growth rates, living in a world with long-term interest rates around 2 percent, and 1 percent inflation. Certainly, investors are willing to pay a premium for these companies given the environment. We can see from the companies listed above that Facebook is the most expensive of the stocks based on the one-year forward PS ratio. 

FB PS Ratio (Forward 1y) Chart

FB PS Ratio (Forward 1y) data by YCharts

On the chart, you can also see that on December 31, 2015, Facebook was trading at a forward PS ratio of 7.69. Today it is 8.7. Alphabet was 4.97; it is now 5.26. Netflix was 4.35; today it is 4.79. And Amazon was 1.92, and today it's 2.27. 

The rise in valuations is due to the increasingly higher expectations for revenue growth; it is not because of pure multiple expansion. 

FB PS Ratio (Forward 1y) Chart

FB PS Ratio (Forward 1y) data by YCharts

GOOGL PS Ratio (Forward 1y) Chart

GOOGL PS Ratio (Forward 1y) data by YCharts

It isn't that these stocks are rising without merit. They are rising and the valuations are expanding because the expectations for them moving forward are rising and growing. 

One last thing to consider as to why these FANG stocks are driving the markets higher is the construction of the Indies themselves. The Nasdaq Composite is a market cap weight index. When the top companies in the index are Apple, Alphabet, Microsoft, Amazon, Facebook, Comcast Corporation (CMCSA), Intel Corporation (INTC), Cisco Systems Inc. (CSCO ), Amgen Inc. (AMGN ) and Kraft Heinz (KHC), you want to see the FANG stocks continue to lead the markets higher.

The FANG stocks are the generals, the leaders, and all the other companies, are the soldiers that follow. If the FANG stocks are struggling, it is probably a pretty good sign that the market as a whole would be struggling. 

Michael Kramer and the clients of Mott Capital Management LLC own shares of GOOGL and NFLX. 

Michael Kramer is the Founder and Portfolio Manager of Mott Capital Management LLC, a registered investment adviser. 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 recommendation made during the past twelve months. Past performance is not indicative of future performance.

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