What Next for FAANG Stocks after Facebook Crash?

Facebook's share price crash has dragged down tech stocks and overshadowed a very positive earnings season for Amazon, Alphabet and Apple

James Gard 2 August, 2018 | 8:37AM
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Facebook Shares Plunge

Facebook’s (FB.) share price crash has been the biggest story of this quarter’s tech earnings season, overshadowing strong performances from Amazon (AMZN), Apple (AAPL) and Google parent company Alphabet (GOOGL).

The biggest question is whether Facebook’s problems will trigger an existential crisis for FAANG stocks in general. Or will this lead to an unbridgeable divide between tech “winners” such as Amazon and the social media giants of Facebook and Twitter (TWTR)?

The bearish argument is that tech stocks have propelled global markets higher in recent years. With the trade dispute between the US and China escalating, and central banks tightening monetary policy, this protracted bull run is due a correction. The bull argument is that companies like Amazon are consistently outperforming and deserve their high valuations.

The actual numbers released by Facebook in its earnings release were impressive, showing revenue growth of 42% year on year and net profits rising 31%. But investors instead focused on the warning from chief financial officer David Wehner that revenue growth rates and margins would fall in the second half of 2018.

The 11% rise in user numbers year on year was also below estimates. By the end of the day the company had lost nearly $119 billion in value, a fall of 20%, one of Wall Street’s biggest one-day declines.

A Buying Opportunity?

Is Facebook’s fall a buying opportunity for those who have been standing on the sidelines during the multi-year tech rally? Not according to Morningstar analysts Ali Mogharabi. While saying that Facebook’s shares are now slightly undervalued, he recommends that investors seek a greater margin of safety before taking the plunge, suggesting that a share price of $150-160 would be the enticing range.

However, Mogharabi believes that the current malaise at Facebook is a “bump in the road” before the firm “realises return on its investments in content quality management and data security in 2020 and beyond, resulting in longer-term margin expansion”.

Twitter followed Facebook in reporting results, and it chose a bad time to report a drop in the growth of monthly active users and warn of a drop in users in the third quarter. Analysts have fretted about Twitter’s user growth in many previous quarters but this time they lined up to downgrade their price forecasts for the stock. Twitter shares, like Facebook, lost 20% on the day of the results, and shed nearly 10% further on Monday.

The Nasdaq Index has been dragged down since Facebook’s results, as have FAANG-focused indices and ETFs. Despite stellar results from Amazon and Alphabet, their shares have suffered from the abrupt change in sentiment away from tech stocks.

Apple Leads Trillion Dollar Race

Among the tech winners, Apple remains on track to become the world’s first trillion dollar company, with Amazon and Alphabet not far behind. All three beat Wall Street consensus figures. Amazon did this in spectacular fashion, posting an increase in earnings per share of over 1,000%, with Amazon Web Services driving much of the growth.

“Even the most ardent Amazon bear would have a hard time finding negatives from its second-quarter update,” says Morningstar analyst R.J.Hottovy, announcing plans to raise the fair value estimate for the company’s shares to $2,200 from $1,900, against a current share price of $1,777. Significantly, Amazon also raised profit forecasts for the third quarter.

Among the FAANGS, Amazon is the only stock to be rated as four stars by Morningstar equity analysts, meaning that they consider it to be undervalued.

A rise in Apple’s shares in after-hours trading to $190 a share drove the iPhone maker’s market capitalisation up to $956 billion. Quarterly revenue and profits beat estimates, as did iPhone selling prices – although the 41.8 million phones sold was below forecasts.

Morningstar’s Abhinav Davuluri maintained the $175 a share fair value estimate for Apple, arguing that prospective investors should wait for any share price fall before committing.

Noting that the company posted a fourth straight quarter of double-digit revenue growth, “loyal iPhone users and many new customers in emerging regions have flocked to the iPhone X, 8, and 8 Plus”, Davuluri says.

Google parent company Alphabet put in another strong performance with a 26% rise in revenue on the year to $32.7 billion. Advertising revenue, helped by growth in YouTube ads and mobile ad spending, was up by a similar amount year on year.

As a result, Morningstar analysts upgraded their fair value estimate for the stock to $1,300 a share – above a current price of $1,227: “Alphabet shares continue to trade in three-star territory; however, we would be buyers of this stock on any pullback.”

Microsoft a Steady Performer

Microsoft is not technically a FANG, having been a listed company for much longer than the other blockbuster tech stocks, and as a result its earnings often attract less interest than the likes of Facebook and Apple.

The company, which has reinvented itself in recent years through its cloud computing division, is considered to be trading below its fair value by Morningstar. Analyst Andrew Lange says: “As the firm's clients' commitment to the cloud increases, we foresee larger and longer-term deals which we think will continue to drive consistent, profitable growth for the firm.”

For the whole financial year, Microsoft’s revenue and profit increases were steady but unspectacular: full year revenue was up 14% at $111 billion, while net profit was up 18% on 2017’s financial year.

Netflix Still Overvalued

Finally, Netflix (NFLX), whose share price has had a stunning run in recent years but has shed around 10% since the most recent earnings release. The company’s stock is rated as one star by Morningstar, which means that it is significantly overvalued. After the most recent set of results, analysts raised their fair value estimate for the stock but said that Netflix faces stiff competition from new entrants, notably Disney, which plan to undercut Netflix’s pricing.

Equity analyst Neil Macker argues that the cost of spending on content will continue to eat away the company’s profits. “We believe that the current stock price reflects a final state in which Netflix is either the only major content provider or part of a duopoly with Amazon, particularly for serial or TV content,” he adds.

What does this recent set of results mean for investors? The FAANG acronym could be under threat, leaving just AAA; Amazon, Apple and Alphabet. As Morningstar ratings and fair value estimates show, the high valuations of tech stocks mean that any nasty surprises lead to significant share price falls. The NYSE FAANG index itself is off 10% from its peak, meaning that it is in correction territory.

Not all FAANGs are equal in prospects or valuations, a point made by Chris Ford, manager of the Smith & Williamson Artificial Intelligence fund: “We believe this divergence in performance is only going to continue, and investors must have their eyes open when it comes to the FAANGs and understand what they actually own. “After all, investors shouldn’t simply buy the whole lot. Like any investment, they need to be discerning and look at them on their individual merits.”

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.

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About Author

James Gard  is content editor for Morningstar.co.uk