Marc Clotet, Clara Caramona, and John Scheilder
Image Source: https://www.msci.com/www/blog-posts/did-faang-stocks-lead-the-us/01135384985
FAANG stocks have proved to be highly profitable during the last decade and remained in the knowledge frontier
But first, what is a FAANG? FAANG is an acronym that refers to the stocks of five prominent American technological companies: Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX); and Alphabet (GOOG)
“If you had invested in Amazon in 1998…”
You might have come across the above phrase while watching an ad by the Motley Fool or from an interesting investing tidbit of information from observers who want to share their hindsight.
What is most interesting? These phrases and others like them are remarkably old. The success of the now established FAANG and Gang has been noted since before the turn of the millennium. In the 1994 classic Forrest Gump, Forrest Gump himself invested in Apple and would have realised at least a 100% return had he bought in the eighties.
Ironically, 25 years after the film’s release, Apple has continued its success. A credulous investor who walked out of the box office, inspired by the film, and bought Apple in 1994 would have seen a 45,000% return, excluding dividends —absolutely remarkable for some kind of fruit company. In fact, one could have taken advantage of this way earlier. To receive the 100% capital gain like Gump did one only had to invest during April of 2020 or, if you wish to ignore that temporary COVID dip, in December 2019.
In August 2018, Apple was the first company to achieve and maintain a $1 trillion nominal valuation. Now there are five public companies with a market capitalisation in thirteen digits, the other four are Amazon, Alphabet, Microsoft, and Saudi Aramco. FAANG and Gang have been able to maintain massive returns through the past two decades.
A Missing Chance?
If the FAANG and Gang have been so consistently innovative since the 20th century, how did investors miss this? Why didn’t investors price this in? The most probable answer is that their terminal values have consistently lowballed the valuation of these companies. Perhaps this might be because the DCFs were too conservative with these companies’ valuations, and that might mean the methods they use are outdated or ill adapted. In a DCF, there are two key areas for error that we see: the discount rate and the terminal growth rate. As most DCFs only forecast five or ten years from the present, they rely on a terminal value to calculate valuations. The theory is that growth past this arbitrary mark cannot be forecasted with any sort of certainty, so analysts assume the firm will not be very innovative anymore. This is rational, but FAANG and Gang have consistently maintained their innovation long after the forecast horizon. As for the discount rate, investors have historically viewed tech as risky. But tech companies use their retained earnings to further dig their competitive moats, which decreases their risk over time.
The above phrases are so common because they have held true for so long. What was a good investment in the 1990s or early 2000s was also a good investment in the late 2010s. They have held so well for so long that one wonders whether this is the new normal. This raises the question in the investing world: “Why is it that the growers keep growing?’
But to answer that question, one may wonder “why is it that they kept growing?” The answer could be deemed to be the same for all the firms: they keep doing what they do really well. It is easy to tell an iPhone apart from an Android, Google search results apart from other search engines, Facebook’s line of services apart from other social media, Windows apart from any linux system, etc. It is hard for other companies to replicate their products, and, therefore, their successes. They work to keep the bar high and are always on the lookout for acquisitions and places to innovate. Apple makes watches and AirPods, Amazon launched AWS, Facebook acquired Instagram and WhatsApp, Google has Android and Chromebooks, and all of them spend billions on new ventures annually. This is what keeps them going. They were the disruptors at one point, and they know that to maintain their positions they have to keep disrupting themselves, further digging their competitive moat.
Innovation at its Height: “Titan”, Apple's New Car Production Project
As of Q1 2021, Apple realised all-time record revenue of $111.4 billion US Dollars, equal to $1.68 EPS (Earnings Per Share). Furthermore, its cash and cash equivalents balance of nearly $38 billion US Dollars also reflects its outstanding financial solvency which it has been able to keep along the last decade. The Board of Directors declared a cash dividend of $0.205 per share which was already paid on Feb. 11 .
It is not only Apple’s fabulous financial position which appeals to international investors, but also its availability to remain in the knowledge frontier. Apple announced plans to produce its own car, the Apple Car! But will Apple be able to outcompete the all-time outstanding German car manufacturers and 21st century’s electric cars? Who will build the Apple Car?
It is well-known that Apple’s success relies on the outsourcing of its products assembly in China (Foxconn Technology Group), a labour-intensive and low-wage jurisdiction. For this reason, it is likely that it seeks for multiple partners and fragments for the car production process, aiming at reducing its input costs . Magna, an Ontario-based company and current supplier of BMW AG, could be one of those partners, coupled with Nissan and several other companies which could bring gripping elements to the table.
Apple’s efficiency of production will be key for its new project. Notwithstanding, having already a notable market share in the technologies industry, if Apple Car proved to be successful, an excessive bargaining power could enable the California-based company to get in volved in rent seeking programs which would shift further down average costs, therefore, crowding out its nearest competitors from the game. This would reinforce the potential to decrease its markup over costs, lowering market prices and having huge influence on its workforce nominal wages.
Disruptive Innovation and Threatening Monopolistic Markets: The Way Ahead
Be it Apple with Titan or the rest of the FAANG and Gang it is clear that the main drive behind their exponential growth is their innovation and capability of diversification. By just taking a look at Apple´s new venture there is no doubt that all these tech companies can keep growing, and perhaps at even faster rates than ever before. But should they be allowed to? Or rather, will they be allowed to? As the American Congress and European Union continue to debate on how to best stop the ever-rising monopolistic power of these Tech-Giants, the future growth of the FAANG and Gang is probably more uncertain than ever.
References and Bibliography
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