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Sector in Focus: FANG Tech Stocks

After taking a hard hit last Friday, US mega-tech FANG stocks extended their losses this week. What is the Morningstar analyst view? 

Karen Kwok 13 June, 2017 | 12:04AM

The US mega-cap tech firms known as the FANG stocks extended their losses yesterday this week, following last Friday’s fall.

FANG is the acronym for four mega-cap technology stocks that have been driving the NASDAQ to new highs this year. Prior to the hiccup last week, the tech-heavy NASDAQ climbed to a new record closing high, to 6,322 on June 8. The index is now down 2.3% from that level.

Shares of FANG stocks Alphabet (GOOG), Facebook (FB) and Amazon (AMZN) are all down more than 4%, from their previous high levels on June 8. Other tech stocks are also affected; Microsoft (MSFT) has also fallen 3%, while Apple (AAPL) is down 6.2% over the same period. They are all rated three-star by Morningstar analysts, meaning analysts believe these stocks are trading at their estimated fair value.

The fourth FANG stock, Netflix (NFLX), currently has a one-star status, meaning Morningstar analysts consider it to be overvalued – despite the fact that the stock is down 8.7% since June 8.

Yet year to date, Alphabet has a 22.2% gain, while Facebook and Amazon are both up 29%. Microsoft has gained 12.3%, Apple is up 25.6% and Netflix has risen up 22.3%.

“Investors looking at the US tech sector now face a key question – has the great rally in tech finally come to an end, or is it wiser simply to follow the trend? In most cases, these rallies go on longer than anyone thinks, so the opportunistic bargain-hunting is likely to continue,” said Chris Beauchamp, chief market analyst at IG Group, the online trading platform.

Data from Morningstar Direct showed that the most popular investment trust on Morningstar.co.uk in the past 11 months, Scottish Mortgage (SMT) has 9.5% of Amazon.com Inc in its portfolio, which is the highest stock holding in the fund. Facebook and Alphabet are also featured in the top 10 holdings in the portfolio, with 4.8% and 3.7% weighting in the fund. The fund fell 2.7% yesterday, however, the fund is up 27.4% year to date.

Netflix (NFLX)

Netflix had a mixed start to 2017 as the firm missed its subscriber guidance but beat Morningstar projections for revenue and segment contribution, said Neil Macker, equity analyst. The firm posted weaker-than-expected subscriber growth in both the international and US segments, Macker added.

“The streaming video on demand market remains very difficult to forecast with precision. For these reasons, we assign Netflix's shares a very high uncertainty rating. The expansion into international markets is unprofitable today, and any material level of profitability may take five years or longer to achieve. Also, Netflix may be overpaying for content due to the presence of Amazon and Hulu. The entry of new competitors may exacerbate the rising cost of content,” said Macker.

Alphabet (GOOG)

Alphabet dominates the online search market with Google’s global market share of above 80%, of which it generates strong revenue growth and cash flow, says Morningstar equity analyst Ali Mogharabi.

Mogharabi expects continuing growth in the company’s cash flow as he remains confident that Google will maintain its leadership in the search market.

“In addition, we view the investment of some of that cash in futuristic projects as attractive. The Google ecosystem strengthens as its products are adopted by more users, making Google’s online advertising services more attractive to advertisers and publishers, resulting in increased online ad revenue. However our uncertainty rating for Alphabet is high, as Alphabet’s high dependency on continuing growth in the online advertising space, along with questions as to whether the company’s moonshot investments will bear fruit,” said Mogharabi.

Android’s dominant global market share of smartphones leaves Alphabet’s Google well positioned to continue generating top-line growth as search traffic shifts from desktop to mobile, while Mogharabi expects slight deceleration of growth in other operating expenses to create operating leverage for Alphabet starting in 2019, partially offsetting decline in gross margin.

Facebook (FB)

The growth in users and user engagement in Facebook, along with the valuable data that they generate, makes Facebook attractive to advertisers in the short and long term, said Mogharabi.

“We believe that the company’s offerings, consisting mainly of Facebook, Instagram, Messenger, and WhatsApp, have further strengthened network effects for the firm, where all of these platforms become more valuable to its users as people both join the networks and use these services,” said Mogharabi.

On average, users are on Facebook and its different apps approximately 50 minutes per day, compared with 40 minutes in 2014. This demonstrates the value of the platform to users, and its network effect for the firm.

Outside of network effects, Facebook also has developed additional intangible assets. Unlike any other online platform in the world, Facebook has accumulated data about each individual with a Facebook account. Facebook has its users’ demographic information, said Mogharabi.

Amazon (AMZN)

Amazon dominates North American online retail with an estimated $180 billion in 2016, sad R.J. Hottovy, strategist with Morningstar. Hottovy said with more than half of the world's Internet users coming from developing markets, Amazon has promising international growth opportunities, including Europe, Japan, and India.

“Amazon has played a key role in the structural shift away from brick-and-mortar retail and will likely lay waste to many other retailers in the years to come. As an increasingly vital distribution channel for consumer product vendors, Amazon commands favourable pricing terms to traditional rivals, which will help drive recurring site traffic. Even with more retailers looking to expand online, we believe Amazon will maintain its consumer proposition through the convenience of Amazon Prime's expedited shipping and expanding digital content library,” said Hottovy.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Alphabet Inc C910.67 USD0.00
Amazon.com Inc958.47 USD0.00
Apple Inc157.50 USD0.00
Microsoft Corp72.49 USD0.00
Netflix Inc166.54 USD0.00
Scottish Mortgage Ord415.46 GBP-1.20-
About Author Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk