Most investors know popular indexes like the S&P 500 and Nasdaq Composite are usually capitalization weighted. The biggest companies by market value have more influence on the index change. The Nasdaq leaders are commonly referred to as the FAANG stocks – Facebook, Apple, Amazon, Netflix, and Google. It’s easy to forget just how much influence these five stocks have, along with Microsoft. This graphic shows the Nasdaq Composite’s component companies as bubbles whose size denotes their share of the index.
We see how a handful of companies dominates the index. More interestingly, those whose names are big enough to read are almost entirely tech-related. Even Amazon, a giant online retailer, is also a key technology provider through its Amazon Web Services unit. Many pundits are saying that a market so dominated by a few companies from one or two sectors is not historically normal and that this represents a bubble, similar to 2000, that is about to burst.
Let’s put rhetoric aside a take a quick closer look at the FAANGS.Stocks are evaluated on their earnings, specifically their future earnings over the next five years. Not their earnings from the past or even the most recent quarter. Yes most stocks look terribly overvalued based on this year’s earnings. But let’s look at the P/E ratio for the FAANGS based on next years earnings estimates.
For comparison, the S&P 500 forward earnings, from www.ycharts.com is 21.94
Facebook – 24.60
Apple – 26.06
Amazon – 82.72
Netflix – 56.24
Google (now Alphabet) – 28.41
At first glance 2 of the 5 FAANGs seem relatively well valued. I’d certainly pay more for both Apple and Google than for the “average” stock on the S&P 500. Neither, it would seem have been overly affected by the COVID pandemic. That cannot be said about Amazon and Netflix. Both companies have seen growth and earnings increase dramatically from the shelter in place COVID lifestyle. The question is whether we will continue to binge watch Netflix and order everything from Hershey bars to new TV’s from Amazon once we feel safe to venture out again? They seem very overpriced in a post COVID world. Facebook is a tough one. While I think their valuation is reasonable, I do not think they will fare well through the election process. They are certain to be criticized by both sides for what they do and what they do not publish on their site. If advertisers continue to leave, Facebook could be in for a tough remaining 2020. Question is whether that will carry further into the future.
Back to the point, is it time to “Short” the FAANGs? Shorting is simply a way to sell stocks now but benefitting from a future price drop. Most of us would not actually “short” the FAANGs. But we do have the option to buy a mutual fund or ETF that does (not advisable) or just not own them now to avoid potential problems later. In fact we may be seeing a rotation from the Nasdaq leading the market to either the DOW or S&P 500 taking over leadership.
This is an example of the problem with Index investing. If you own a fund or ETF that invests in the Nasdaq index your fate is tied to he FAANG stocks. Period. And there are certainly stocks to avoid in the Nasdaq beyond a couple of FAANG stocks. But there are many really good companies too. And even if these company’s stocks outperform, that performance could be wiped out by a few percentage point losses in the largest FAANG stocks. Make no mistake, the FAANGs move the Nasdaq.
At 401 Advisor, LLC we believe in proactive asset management. Too many people seem to think the only options to an investor are to hold stocks or sell them. We prefer a more subtle approach of finding areas of opportunity and selling areas the present a higher risk. We will be watching the three major indexes and if we see this rotation away from the FAANGs we are prepared to rotate our client holdings as well.
We currently hold QQQ in our client portfolio’s and may hold QQQE. Please feel free to contact Jim or myself if you have questions or would like to discuss your investment portfolio and stratgy.
Mr. DeShurko is the Managing Member of 401 Advisor, LLC an independent registered investment advisor. Jim Kilgore CFP ® is an Investment Advisor Representative of 401 Advisor, LLC. They are also registered representatives of Ceros Financial Services, Inc. (Member FINRA/SIPC). Ceros is not affiliated with 401 Advisor. The views expressed are those of Mr. DeShurko and do not necessarily reflect those of Ceros Financial Services, Inc., its employees, or affiliates.
Past performance is no guarantee of future results. All investing involves risk. Investments mentioned are not meant to be specific buy or sell recommendations without being taken in the context of an investors’ entire portfolio or investment objectives. Consult an investment professional before investing.
Market rally market crash