Being an investor in 2020 hasn’t been easy. The unprecedented coronavirus disease 2019 (COVID-19) pandemic has created meteoric plunges and rises in the market; it even sent the CBOE Volatility Index to its highest reading in history in March.
But amid the chaos, one group of stocks has stood out as a clear outperformer: The FAANGs.
The FAANG stocks have been a popular buy in 2020
The FAANG acronym describes:
These industry leaders have been running circles around the broader market for much of the year. Even taking into account the marketwide retracement in equities since the beginning of September, Facebook, Amazon, Apple, Netflix, and Alphabet are up a respective 21%, 61%, 50%, 51%, and 8% on a year-to-date basis through Monday, Sept. 21. That compares to a less than 2% gain for the benchmark S&P 500.
You might be under the impression that Wall Street and retail investors have been buying into the FAANG stocks hand over fist in 2020. After all, these companies are leaders in their respective industries. For instance, Alphabet’s Google controls the lion’s share of internet search, Facebook owns four of the seven most-visited social media sites, and Amazon controls 44% of all online sales in the U.S.
But the optimism surrounding FAANGs might be overstated.
Big money ran for the exit in Q2
In case you missed it, Friday, Aug. 14, represented the filing day for Form 13F with the Securities and Exchange Commission from money managers with at least $100 million in assets under management. A 13F provides a snapshot of what money managers and hedge funds were holding as of the end of the previous quarter (in this instance, June 30). Although the data can be a bit outdated — after all, it’s released approximately 45 days after a quarter ends — it still gives Wall Street and investors some idea of what the brightest minds on Wall Street have been up to.
Given how strongly the FAANG stocks rallied during the second quarter, you’d probably surmise that money managers piled into these companies. Yet that’s not the case. Aggregated 13F data from WhaleWisdom.com shows that the total number of FAANG shares owned by entities required to file a 13F actually declined across the board from the first quarter into the second:
- Facebook: Down 0.01%
- Amazon: Down 10.84%
- Apple: Down 5.03%
- Netflix: Down 2.13%
- Alphabet: Down 1.97% (Class A, GOOGL), Down 2.59% (Class C, GOOG)
The vast majority of brand-name or high-growth stocks saw their ownership among 13F filers increase during Q2, not decline. In other words, selling wasn’t par for the course in Q2.
Why did successful money managers sell the FAANGs in the second quarter?
Why did professional money managers run for the exit during the second quarter?
One possibility is they simply saw this exceptionally fast bounce from the March 23 lows as likely to run out of steam. The FAANGs comprise a large percentage of the market’s major indexes, and were thus responsible for pushing equities higher throughout the quarter. In hindsight, we know that money managers made a poor choice to reduce their positions or exit their stakes entirely. But prior to the coronavirus crash, no bear market decline had ever been erased so quickly. Money managers usually bank on history repeating itself.
The 13F filers may have also sold the FAANGs to diversify. Although tech stocks outperformed in a big way during the second quarter, and growth stocks have been running circles around value stocks for the better part of the past decade, the period following a recession normally sees a rotation toward safer sectors, like consumer staples, and value stocks.
A third and final possibility is that money managers were terrified of certain FAANG stock valuations. Apple, for instance, climbed above a price-to-operating-cash-flow ratio of more than 20 — a level it hadn’t consistently seen (aside from the first quarter of 2020) in more than a decade. There’s also Amazon, whose price-to-earnings ratio surged well above 100. And finally, Netflix shares surged despite the company continuing to burn cash.
More downside may await — but that’s not a bad thing
Whatever the exact reason(s), it’s pretty evident that there’s skepticism about FAANG stock valuations, at least in the short term. These concerns may be further magnified by the possibility of a coronavirus resurgence during the fall or winter, and the potential for another nonessential business shutdown. Election results could also have an impact.
However, investors shouldn’t fear additional FAANG downside. Rather, it should be cheered, because it could give long-term investors yet another opportunity to buy into these time-tested and dominant businesses on the cheap.
Recently, I’ve been outspoken about the lack of value that Apple has offered investors prior to and following its 4-for-1 stock split. For a brief period, Apple was being valued like a service company, yet had only generated 19% of fiscal year-to-date sales from higher-margin and faster-growing services. Apple’s stock has now declined roughly 20% from its all-time intraday high, and it could face more downside as investors realign Apple’s stock with its historic valuation multiples.
But this doesn’t mean Apple can’t eventually outperform. It’s still the dominant smartphone company in the U.S., and its reliance on services is growing. This would suggest that record quarters of cash flow and revenue are yet to come.
Likewise, Amazon can still offer incredible value if you’re patient. Though known for its dominance in online retail, Amazon’s infrastructure cloud segment, Amazon Web Services (AWS), is growing into a larger component of its overall business. The margins associated with AWS are substantially higher than the margins Amazon generates from retail and selling advertising space. If Amazon were to simply be valued at the midpoint of its price-to-operating-cash-flow multiple over the past decade, its share price could easily double in value over the next three years.
More downside in FAANG stocks? Yes, please.