The mega cap FAANG tech stocks have been key drivers of bull market gains in the major U.S. stock indexes. As 2018 progressed, however, doubts about their valuations and capacity for future growth increased, eventually sending all five into bear markets, down by 20% or more from their highs. All have staged partial recoveries.

The FAANG stocks are Facebook Inc. (FB), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Netflix Inc. (NFLX), and Google parent Alphabet Inc. (GOOGL). They differ in terms of markets, business models, levels of risk, and growth phases. It thus is misleading to view them as a group.

"You have to differentiate between all the stocks that fall into that same basket,” as Shawn Cruz, manager of trader product and business strategy at brokerage firm TD Ameritrade, told Markets Insider. "What the markets are telling you is that they think the earnings estimates assigned to Google, Facebook, and Apple are much riskier than the earnings estimates that are assigned to Amazon and Netflix." He bases this observation on their widely varying forward P/E ratios.

All FAANGs Are Not Alike

(Forward P/E Ratios)

  • Amazon: 61 times estimated earnings for the next 12 months
  • Netflix: 53 times
  • Alphabet: 24 times
  • Facebook: 23 times
  • Apple: 13 times

Source: Thomson Reuters, as reported by Yahoo Finance

Significance for Investors

As shown above, Amazon and Netflix have significantly higher valuations than the others. Cruz sees greater investor confidence in their future earnings, and thus less risk for these two.

Others disagree. They view high valuations for Amazon and Netflix as indicative of much greater risk. By anticipating very high levels of growth extending far into the future, these valuations can be shattered by the slightest disappointments.

The FAANGs' Roller Coaster Ride

(High to Low in 2018, 2018 Low to Feb. 7, 2019 Close)

  • Facebook: -43.7%, +35.2%
  • Amazon: -38.3%, +27.5%
  • Apple: -39.1%, +20.4%
  • Netflix: -45.4%, +49.1%
  • Alphabet: -24.3%, +13.1%
  • S&P 500: -20.2%, +15.3%

Source: Yahoo Finance

Apple is primarily a seller of devices, with the iPhone having supplanted the Macintosh line of personal computers as its flagship product. It also is by far the oldest and most mature FAANG member, and its relatively low P/E ratio reflects its lower prospects for growth. Indeed, the personal computer market is in long term decline, and the smartphone market may be reaching saturation, with Apple reporting a 15% sales decline in iPhones during its recent fiscal quarter that included the holiday shopping season.

Another major source of revenue for Apple is its App Store. A growing headwind comes from application providers, mostly notably Netflix, that no longer accept customer payments through Apple's system, thereby reducing the commissions that Apple earns on these transactions, per reports in Seeking Alpha and The Verge. Google Play, which offers apps for devices that run Alphabet's Android operating system, faces the same problem.

Amazon is mainly an online retailer, but its "go anywhere" attitude has made it a fast-growing player in diverse areas like cloud computing, video streaming, and voice-controlled devices such as Alexa. Indeed, as a retailer it has branched out from its origins as a bookseller to become a vendor of virtually every product imaginable, as well as providing the leading online sales platform for smaller merchants. Amazon is still in an aggressive growth mode, sacrificing current profits to build market share through highly competitive pricing.

Alphabet is the developer of Google, the dominant internet search engine, and Chrome, a popular web browser. It derives most of its revenues from online advertising, and offers video streaming through YouTube. Alphabet also offers cloud services, has entered device markets with mixed success, and its Waymo unit spends significant R&D dollars on developing autonomous vehicle technology.

While 4Q 2018 EPS beat estimates by 18.0%, Alphabet's stock sank on the news, based on rising costs and a 29% year-over-year (YOY) decline in advertising revenue per click, CNBC reports. Amazon is emerging as a serious competitor in online advertising, contributing to Google's eroding pricing power.

Facebook, the pioneering social media site, also depends on advertising revenue and is expanding into video streaming, with a focus on sporting events. Like Alphabet, it has drawn political fire over privacy issues and its ability to influence public opinion. Nonetheless, Facebook reported record profits in 4Q 2018, up 61% YOY.

Netflix is adding nearly nine million new paid subscribers globally each quarter. Cruz believes that it is still in the early stages of growth. Others wonder if it is reaching market saturation in the U.S. with over 60 million subscribers. Accordingly, the company focuses on international growth, and has over 148 million users worldwide, per Statista.

Looking Ahead

Investors must make nuanced decisions about the FAANGs. Those who value established profitability and a dividend may prefer Apple, despite its growth issues. Others who prize fast growth in anticipation of big future earnings may favor Amazon and Netflix, but should be cognizant of the potentially higher risks.