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The big five: Why Alphabet, Amazon, Apple, Facebook and Microsoft are superb stocks to own
It’s almost impossible to talk about the general stock market without including the big five tech titans in the conversation. Google-owner Alphabet, Amazon, Apple, Facebook and Microsoft are as well-known to UK investors today as Lloyds (LLOY) or Sainsbury’s (SBRY), the ubiquity of their products and services as wide as Heinz baked beans.
Often referred to by the acronym FAAMG (or GAFAM, take your pick), many investors remain reluctant to invest despite a decade of incredible returns. Shares believes all five companies are essential stocks to own and investors would be wrong to ignore them.
Together, FAAMG stocks have generated an average total return (share price plus dividends) of 50.5% a year over the past decade. By contrast, the S&P 500 has delivered an equivalent 16.3% annual return since 2011. Even the Nasdaq Composite, the tech sector’s banner benchmark, has performed less well, putting up 44.9% annual return.
WHY HAVE THEY DONE SO WELL?
There are multiple reasons why FAAMG stocks have performed so impressively over 10 years. The internet has become one of the most vital tools for communication, information and entertainment in today’s globalised world. While technological advances continue to accelerate the digitisation of modern life, it is the FAAMG companies that dominate the digital universe.
The five tech giants boast user bases in the billions and a combined market value of more than $9 trillion, making them the largest digital commerce companies anywhere. With every new product, service and innovation, the big five cement their digital imprint and expand their influence on the global economy.
This has allowed them to continue to grow at a rapid pace. It was only August 2018 that Apple became the first listed company ever to break the $1 trillion valuation bar – now all five have broken through that glass ceiling, while they all feature in the world’s top 10 most valuable brands.
Many investors believe these stocks are too expensive. Buying shares trading at 40-plus times earnings may not sound like a good idea but that is exactly what Maneesh Deshpande, Barclays’ head of equity derivatives strategy, has been telling clients to do.
As stretched as the FAAMGs may look, at an average a 32% premium over the S&P 500 Index, Deshpande says judging valuations based on an absolute level or comparing them to the rest of the market is flawed because it doesn’t acknowledge the growth advantage that these tech giants offer in the long run.
In other words, they deserve a higher multiple because of their superior earnings power. And superior earnings are what the big tech five have been delivering.
FAAMG stocks at a glance
Facebook owns two of the most engaging and largest social media apps in the world – its namesake, Facebook, and Instagram – as well as two of the biggest messaging apps, WhatsApp and Messenger. It makes money by displaying advertisements to users while they browse through feeds of photos and videos.
Amazon is the largest business-to-consumer e-commerce company in the world. Its Prime membership program has more than 200 million global subscribers who have proven loyal to the company’s online marketplace. While e-commerce accounts for the bulk of its revenue, Amazon has found profit engines in cloud computing services and advertising.
Apple is one of the biggest smartphone manufacturers in the world. Device sales account for most of Apple’s revenue, but in recent years the company has also focused on higher-margin subscription services, including streaming music and video, gaming, news and cloud storage.
Microsoft is one of the world’s most dominant software companies with millions of businesses and private users relying on its Windows operating system to power PCs and laptops. Business applications remains its core source of profit, largely recurring because users get tied into its ecosystem, but it is also building a vast cloud computing empire that is highly profitable and growing fast.
Alphabet is a tech conglomerate primarily split between Google and other interests. While Google started as an internet search company, it’s continued to acquire and develop consumer-facing products, nine of which boast more than one billion users each. Google also encompasses a growing cloud computing business and a relatively small hardware business. The other parts of its business include automated-vehicle venture Waymo and health researcher Verily.
Amazon was the last of the big five tech companies to report its earnings for the three months to 30 June 2021, and like the other four FAAMG companies, the quarter was a record-breaking one, despite falling just short of expectations in terms of sales and next quarter guidance.
The e-commerce behemoth saw net sales grow 27% to $113 billion in the three months, partly offsetting a slowdown in its core e-commerce business with strong growth in its cloud and advertising segments.
While chief financial officer Brian Olsavsky was quick to point out that the slowdown in year-over-year growth was mostly due to unusually strong results caused by lockdowns in second quarter of 2020, Amazon’s shares still tumbled more than 7% following the announcement. That looks like an over-reaction.
While Facebook and Apple also offered modest guidance, warning investors that the blockbuster growth rates achieved over the past 15 months couldn’t be sustained forever, there were few signs of weakness in big tech’s second quarter results.
The entire FAAMG group saw profits surge in the June quarter as big tech continued to profit from the pandemic’s stimulating effect on online advertising, e-commerce and consumer spending. As the chart shows, each of the five companies crushed their previous record for June quarter profit, with Apple, Alphabet and Facebook almost doubling their previous best.
FAAMG stocks had a tough start to the year but they are now getting a break from investors after lagging the market for most of 2021.
‘You really have a group that’s underperformed the broader tape, that is still growing earnings and that’s how they get cheaper,’ said Art Hogan, chief strategist at US broker National Securities. As the analyst points out, a company capable of consistently growing in the double-digits should probably be ascribed something higher than one in mid-single digits.
Indeed, the FAAMG’s combined income expanded by an annual average 15% in the past five years, four-times the S&P 500, according to data compiled by Bloomberg Intelligence. While their growth is expected to begin lagging in the three months to September, their edge will likely return next year, analysts say.
The growth of the tech industry’s powerhouses and their unmatched market dominance has far-reaching consequences for online users, competitors and the internet’s entire architecture.
By acquiring successful companies and newcomers (Facebook bought Instagram and WhatsApp) and promoting their own products and services (on Google’s search results), the tech giants’ oligopoly can eliminate competition and reduces digital diversity. This concentrated power has frequently prompted calls for antitrust action.
Since Microsoft’s early antitrust battle in the 1990s, a series of lawsuits were filed to regulate big tech’s grip on the internet and democratise digital infrastructure.
Between 2017 and 2019, the EU Commission fined Google over €8 billion for anticompetitive behaviour. Considering that FAAMG companies are among the top lobbying spenders in the US, antitrust investigations against Google, Amazon, Facebook and Apple could potentially undermine their ability to maintain the dominance in internet markets in the future, or at least unsettle investors enough to upset share prices periodically.
That said, Blue Whale Growth Fund’s (BD6PG78) manager Stephen Yiu welcomes increased regulation in tech as it solidifies incumbent positions and makes it harder for disruptors to usurp them.
Interestingly, the fund believes that breaking up some of these tech titans, as has been threatened, could be good for shareholders since it believes they are now so big and ubiquitous, many of the stocks now come with a ‘conglomerate discount’.
UNLOCKING NEW PROFIT ENGINES
From electric and self-driving cars to augmented reality and virtual reality headsets, the tech giants have plenty of projects that could move the needle for them later this decade.
Assigning valuations based solely on the earnings thrown off by their current profit engines arguably fails to do justice to their other businesses and projects that could become major profit contributors down the road.
Read on to discover some of the ‘in development’ initiatives that are currently generating little or no income for Alphabet, Amazon, Apple, Facebook and Microsoft but where the story could be different in a few years’ time.
Waymo is Alphabet’s self-driving car project. Progress (like that of the autonomous driving space at-large) has been slower than what many once hoped, and we remain years away from widespread autonomous vehicles.
Even so, Alphabet is still arguably the technology leader in the field. Over the next several years, Waymo’s driverless taxi services, for now, available in just a part of the US city of Phoenix, could become available to a much larger number of consumers, and its partnerships with automakers such as Volvo, Fiat Chrysler and Nissan-Renault could yield commercial vehicle launches.
In contrast to Waymo, Google’s public cloud operation is already a large business, yet it is currently losing money hand-over-fist.
In 2020, the Google Cloud segment, which covers both Google Cloud Platform – also known as GCP – and the Google Workspace productivity app business, posted a $5.6 billion operating loss on revenue of $13.1 billion, with GCP investments believed to account for much of the losses.
But GCP, which often gets high technical marks from cloud developers, also continues to see double-digit growth. In time, a combination of continued revenue growth and slowing spending growth should help GCP turn profitable.
In the short-term, Amazon’s budding grocery delivery operations are at a scale disadvantage relative to rivals with larger retail store footprints to leverage for inventory and fulfilment.
But in the long term, Amazon’s giant and steadily growing warehouse footprint, together with its delivery infrastructure, should give it important cost advantages.
That in turn could allow Amazon to profitably take share in a $700 billion-plus US grocery industry that still sees the lion’s share of its sales take place offline.
Amazon’s massive advertising business, which is expected to bring in more than $25 billion in revenue this year, revolves heavily around product and brand advertisements shown on its shopping websites and apps.
However, with the help of its customer relationships and shopping data, the company is laying the groundwork to also sell quite a few targeted advertisements via streaming services (including its own) and third-party websites and apps.
A recent deal to gain exclusive distribution rights to the NFL’s Thursday Night Football games will aid this effort, and so does Amazon’s reported plans to launch an identifier that would help it deliver and measure the performance of targeted advertisements on third- party properties.
Amazon has invested billions in its Indian e-commerce operations in recent years, spending that has helped it become (along with Walmart-controlled Flipkart) a top two e-commerce player in the world’s second-most-populous country.
It should get a good payoff from those investments this decade, as India’s economy and e-commerce penetration rates keep growing.
In addition, the Middle East, where Amazon established a large presence in 2017 via its acquisition of e-commerce site, Souq.com, could become an international growth engine. So might Latin America, where Amazon has been gradually increasing its efforts to compete against local e-commerce giant MercadoLibre.
A slew of media reports arrived in late 2020 and early 2021 stating that Apple is looking to launch an autonomous electric car somewhere in the middle of this decade.
While Apple reportedly wants its cars to be fully driverless from the start, the vehicles might only operate in a limited set of environments at first. But the company’s engineering pedigree works in its favour as it tries to launch a differentiated solution in a crowded field, as does its knack for crafting end-to-end experiences covering hardware, software and services.
And when a car has no steering wheel, pedals or need for traditional driver visibility, its designers can get creative about what its interior looks like.
Apple is reportedly looking to launch a high-end, low-volume, augmented reality/virtual reality headset for developers and enthusiasts in 2022, followed by a lightweight pair of AR glasses further down the line.
Much like autonomous driving, creating a mass market for consumer AR hardware remains a work in progress, as technical challenges related to aspects such as display resolution, field of view, battery life and miniaturisation continue to be worked on.
But between its chip and hardware engineering chops, its ability to pair AR headsets with iPhones and the large ecosystem that already exists for its ARKit platform for developing AR-capable mobile apps, there’s arguably no company better positioned to take consumer AR mainstream than Apple.
This is a niche market right now with only a few manufacturers (Samsung and Huawei among others) to have launched innovative devices that appeal to a subset of high-end phone buyers.
Prices are high and there are significant technological shortcomings that prevent a true mass-market from forming.
But considering how many consumers love having additional screen space, it feels like only a matter of time before a mass market does form, lifting smartphone average selling prices and upgrade rates in the process.
Apple, which has obtained various foldable phone-related patents and is reportedly looking to launch its first foldable device in 2023, probably won’t be left out when a mass market emerges.
Facebook has moved cautiously when it comes to monetising Messenger and WhatsApp, which claim, respectively, more than 1.3 billion and 2 billion monthly active users.
The company is gradually making good on Mark Zuckerberg’s vision of having its messaging platforms act as customer service and engagement channels for businesses marketing and selling on Facebook’s core app and Instagram.
In addition, WhatsApp’s product catalogue feature creates an e-commerce opening for the platform, and (though Facebook is opting not to do so for now) its stories service, known as Status, could eventually be monetised via advertisements.
The pandemic helped VR headset sales jump over the past 15 months, and no headset vendor benefited more than Facebook’s Oculus unit, which now appears to be on a $2 billion-plus annual revenue run rate.
Still, compared to tablets or even smartwatches, VR headsets remain in their infancy. And between the aggressive pace at which it keeps raising Oculus’ headcount and the steady pace at which it keeps making VR-related acquisitions, Facebook seems quite intent on being a major VR platform provider over the long haul.
Facebook’s Shops e-commerce platform, which launched in May 2020 across Facebook and Instagram, now claims more than one million active sellers and more than 250 million interacting users.
Facebook Marketplace, the company’s Craigslist/Ebay rival, now has more than one billion people using it.
Both platforms stand to strengthen Facebook’s advertising business in the coming years, given that they both allow consumers clicking on advertisements to make purchases without leaving a Facebook-owned app and allow Facebook and its advertisers to track when an advertisement click led to a sale with 100% accuracy. Perhaps in time, the platforms might also generate meaningful commission- based revenue.
Microsoft is pulling out all the stops to make its $15 a month Game Pass Ultimate service (bundled Xbox Live Gold, the Xbox Game Pass game download service and Microsoft’s new Xbox Cloud Gaming service) a marquee subscription gaming franchise.
Between Microsoft’s Xbox user base, cloud infrastructure, relationships with third-party game publishers and own large game library (made larger by the recent Bethesda Softworks acquisition), Game Pass Ultimate looks poised to become a substantial business over the next few years.
Including both Game Pass Ultimate and cheaper plans, Microsoft had 23 million Game Pass subscriber as of April 2021. It’s not hard to imagine that number surging past 50 million in the coming years.
With its Dynamics software suite, Microsoft has for some time been a major supplier of customer relationship management and enterprise resource planning apps to small and mid-sized businesses. Now, with the help of growing traction for Dynamics 365 cloud apps, Dynamics is making more headway within larger organisations.
While competition is intense (Oracle, SAP, Salesforce and Workday among them) there’s still a lot of room to grow, as Microsoft continues differentiating Dynamics 365 apps by integrating them with platforms such as Teams and LinkedIn, as well as by embedding a variety of data sharing, analytics and machine learning features. Research firm IDC estimated the total enterprise applications market was worth nearly $225 billion in 2019, with Microsoft holding a modest 2.1% share.
The investment case
All five FAAMG companies have assets that should make them more profitable than their rivals.
Facebook, Amazon, and Alphabet have troves of user data they can use to target advertisements. Microsoft has become the leading software company for business, while Apple has built a large and loyal iPhone user base that is increasingly embracing high-margin apps and services.
The question on everybody’s mind is how long these behemoths will be able to sustain current growth rates. We think they can achieve above-market averages for years to come, meaning these stocks should serve your portfolio well if held for the long term.
All five stocks can be easily bought via UK investment platforms. The alternative is to buy exchange-traded fund GraniteShares GAFAM (GFME) which tracks the performance of an equally weighted basket that contains Alphabet, Apple, Amazon, Facebook and Microsoft.
The main UK investment platforms should let you buy the US dollar-denominated version which has the code GFAM. There is a sterling-denominated version with the code GFMP, but availability is limited on the main investment platforms at present. This is a relatively new product, and it might take some time for it to become widely available.
The ETF charges 0.69% a year and may suit investors who only have a small amount of money to put into these companies, given some of the individual stocks cost several thousand dollars for a single share.
DISCLAIMER: The author Steven Frazer owns shares in Blue Whale Growth Fund.