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Jonathan Poland
Jonathan Poland
Articles (225)  | Author's Website |

FANG Stocks Are Overpriced

How much longer can these stocks trade at current market multiples?

The long-term value of Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet's Google (NASDAQ:GOOG), or FANG, is extremely high compared to the marketplace as a whole, but the price placed on each individual company’s stock today is quite absurd.

Make no mistake about it, these are top-tier businesses generating billions in sales and profits annually. However, looking at them in terms of the growth necessary to justify current valuations, the returns will have to be extraordinary. With each trading at high market capitalizations based on historic growth, the likelihood current and new buyers would beat the overall market is low.

Facebook

The fastest-growing company in terms of profits is also the one that gives us pause. At the end of the day, Facebook is not a social network, it is an advertising platform. If WPP PLC (NYSE:WPP) or Omnicom (NYSE:OMC) had built a network of attention, Facebook would not be what it is today. The future will give a similar answer to the next generation of growth stories.

Revenue: $36.4 billion
Income: $15.2 billion
Price: $545 billion
Price-earnings  (P/E) ratio: 35 times

Amazon

Amazon is the largest FANG stock in terms of revenue and generates a ton of operating cash. But with a $565 billion valuation, the net earnings it would need to generate just to justify this price needs to be 20 times higher. If the stock was priced like Walmart (NYSE:WMT), it would be close to 80% cheaper. I am not disputing Amazon’s place in the market, or the fact it generates a hefty amount of cash that could be pushed to the bottom line. It just has to do too many things right in the coming years to justify today’s valuation.

Revenue: $161.1 billion
Income: $1.9 billion
Price: $600 billion
P/E ratio: 314 times

Netflix

Netflix is another company that could be considered a darling of Wall Street. Priced at 80 times 2018 expected earnings, it kills cash flow because of the amount of content it produces. That will eventually catch up to the earnings once growth slows.

Revenue: $10.8 billion
Income: $440 million
Price: $91.5 billion
P/E ratio: 214 times

Google

The most valuable FANG company, at $726 billion, is Google parent company Alphabet. Like Facebook, it is heavily dependent on advertising revenue – close to 90% of its annual sales – despite dabbling in other ventures like smartphone software. If advertising spend on the Adwords network drops because the return on investment is better elsewhere or made easier, then Google’s value will flatline or fall off.

Revenue: $104.5 billion
Income: $21 billion
Price: $775 billion
P/E ratio: 37 times

Conclusion

Who will build a better advertising or social platform? Who will compete on content with Netflix? Where will future consumers shop most? How many new ad platforms will compete and win against the FANG stocks? How high are switching costs to the new platforms? Where will Virtual Reality fit in? How will AI play a part? Will VR, AR, or AI actually matter? All these questions play a role in valuations.

Out of the FANG stocks, Facebook seems to be the most fairly priced with multiple platforms driving massive user attention and engagement, which leads to advertising spend. The company still has not fully monetized, so that could deliver massive future profits. With a young guy like Mark Zuckerberg leading the way, we expect Facebook to be the long-term winner from this group, especially at this price level.

Even without an impending market correction, however, these stocks are overpriced, overbought, overhyped and the prosperous run in each is most likely over.

Disclosure: I am not long/short any stocks mentioned in this article.

About the author:

Jonathan Poland
Thanks for reading! I'm a former money manager and financial publisher that has helped investors produce market beating results since 2001. Today, I turn 40,000 hours of work analyzing and forecasting the world's leading investments into models for better business development.

Visit Jonathan Poland's Website


Rating: 3.7/5 (7 votes)

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Comments

middleman
Middleman premium member - 5 days ago

I think this analysis ignores R&D. Hard to say how much of the R&D "expenses" are actually capex, but I think it's significant. Add some of the R&D back and the PE ratios look better. Also ignores the large cash balances. I don't try to forecast which tech will win, I just buy nasdaq 100 (PE ~27 before adjusting for R&D) and let it roll. Also, trailing PE isn't nearly as indicative when you have significant earnings growth. Adjust the PE ratios by taking most recent earnings quarter x 4. 2017Q1 is useless data for PE calcs when earnings are growing 20 percent.

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