Are the FAAMG stocks a buy today?
With 2023 kicking off a new year many investors are wondering if this is a good time to place some fresh bets on the FAAMG stocks? Many of the FAAMG stocks are bouncing off mid-October lows and appear to be regaining their footing. Will 2023 be a better investing climate for the Technology sector, opposed to the recent challenges facing the group during this post COVID/Fed tightening environment?
For some investors, this year’s rout in high-flying technology stocks is more than a bear market: It’s the end of an era for a handful of giant companies such as Facebook parent Meta Platforms Inc. and Amazon.com Inc. Those companies — known along with Apple Inc., Microsoft and Google parent Alphabet Inc. as the FAAMGs — led the move to a digital world and helped power a 13-year bull run.
Many of the large FAAMG stocks has exhibited a substantial slowdown in profit growth and in some cases growth has simply evaporated -- like in the instance of Meta. Meta’s net income is projected to drop by 32.6% in 2022 compared to a year ago. While the sheer size of companies like Amazon, Apple, Microsoft and Alphabet may make it difficult to deliver strong future top and bottom line growth. Should investors consider these Tech giants as simple mature growth companies possessing little of a catalyst to generate above market returns?
The answer is that each company operates in distinct segments within the Technology landscape and their businesses are impacted in different ways. For example, both Amazon and Microsoft compete in the fast-growing IaaS cloud data center segment (Amazon’s AWS and Microsoft’s Azure), yet Amazon’s core E-Commerce Market Place and Microsoft’s desktop operating software business could not be more different. Microsoft and Amazon lead the total cloud market with a combined 30% share, with Microsoft gaining an edge with its Microsoft 365 suite and above-market cloud-infrastructure product growth.
Though Amazon generates most of its cloud sales (over 95%) from cloud-based infrastructure products (IaaS), while Microsoft's breakdown is split more evenly between applications (57% of cloud sales) and infrastructure (43%). Total Cloud spending was $418 Bn in 2021 and is expected to grow to $530 Bn in 2022 resulting in a projected CAGR from 2021-2026 of 21.3% (according to data collected by IDC.)
each company operates in distinct segments within the Technology landscape and their businesses are impacted in different ways
Both Meta and Alphabet dominate the social media space with their trademark sites like Meta’s Instagram, WhatsApp and Instagram. Alphabet’s Google Search and advertising marketplace are the gold standard in matching advertisers with available space. Together they dominate 70% of the overall on-line ad market.
Internet ad spend rates continue to be impacted by the Ukraine conflict, macroenvironment headwinds and increasing competition for advertising dollars that are now growing more slowly -- for Alphabet and Meta -- that is creating an overall smaller advertising pool. According to a recent study from PSC Research the Digital Advertising Global CAGR over the next 10 years is projected to be 13%. In 2021 Digital Advertising Spending was $432 Bn, which is projected to grow to $490 Bn in 2022 (+13 YoY) and $532 Bn in 2023 (+8.5% YoY).
Faced with a higher cost of borrowing and rising inflation, investors are becoming more exacting in terms of which companies they are willing to back. Big capital projects on unproven technologies, such as Meta’s bet on the metaverse, haven’t gone down well. Many investors are not sure if the metaverse, along with the virtual reality (VR) headsets is going to ever become profitable. Further, these fledgling businesses along with a struggling core adverting business may make future profit growth more challenging.
Apple continues to be the “Mercedes Benz” of the mobile phone market commanding some of the highest margins in the cell phone space. Apple is highly reliant on strong consumer spending on electronics like iPhones, iPads, Watches, and Mac PCs to drive growth. With world economic growth slowing and consumer spending waning many investors are concerned that demand for Apple’s key products will be sluggish. But, many analysts do not think the iPhone cycle is over just yet.
Strong iPhone performance was notable in recent quarters in light of the supply constraints, as well as the lack of a form factor change on iPhone. In 2020 sales were constrained because of lockdowns, and in 2021 sales were affected by component shortages. For that reason, expect there’s a good chance the 5G upgrade cycle could get extended, since Apple wasn’t able to reach the entire market. Coupled with what is likely to be a more significant iPhone form factor change next year, gives ample reasons to stay constructive.
Some of today’s FAAMG stocks may end up being unseated by a new set of Tech high flyers. Much like how Wall Street no longer is consumed over the “Four Horseman” – Cisco, Dell, Intel and Microsoft – of the late 1990’s! During the late 1990’s the “Four Horseman” combined market value accounted for nearly 14% of the S&P 500’s capitalization.
Microsoft is the only remaining member of the original “Four Horseman” that still grabs some of the spotlight. Former “Four Horseman” Cisco Systems and Intel, leaders in networking and PC chip space during the “Dot.com” boom of the late 1990s, have not seen their stock prices climb back to the highs they reached in 2000. While it took the NASDAQ 100 Index 15 years to surpass its former 2000 peak.
But investors are reassessing their longer-term potential now that societies have reopened and higher interest rates around the world have damped risk appetites. One of the biggest draws for investors has been the super-charged growth rates that technology companies offered. Now the growth looks more pedestrian. For example, the “Super Charged” pandemic profit growth rates for the Information Technology sector are now expected to slow to just 11.2% in FY23 and 13.1% in FY24.
With market technicals now favoring the bears, there seems to be a flight to value within the technology sector , as lower multiple, more mature growth names are out-performing their once high multiple, fast-growth brethren. For example, the once high-flying darlings Netflix (-52% year-to-date), Meta (-65% year-to-date), Amazon (-48% year-to-date) and Alphabet (-38% year-to-date) have gone through a drastic reevaluation of expectations for their future profit growth.
In contrast, more mature technology names like IBM (+5% year-to-date), ADP (+1.5% year-to-date), and Oracle (-6.9% year-to-date) have posted respectable returns so far this year. To that end, these mature growth companies, IBM, ADP, and Oracle have strong cash-flow, healthy share repurchase programs, and pay a decent dividend yield.
Two years ago, investors could have thrown a dart at a FAAMG dart board and would have pretty much come up a winner. Should investors just blindly throw money into an ETF that just buys only FAAMG stocks? That’s probably not going to work anymore! Understanding the different trends impacting each sector within the tech space that each FAAMG stock operates in and how those companies stack up against the competition will provide the clues to investors to determine future winners and losers!
Daniel Morgan, Senior Portfolio Manager
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