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What's next for the FAANGs?

James Gard  |  08 Aug 2019Text size  Decrease  Increase  |  
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Another eventful US tech earnings season draws to a close and there’s still little sign of the technology boom ending. The Nasdaq tech index hit another record high, surpassing 8,300 points on the back of strong results from Google parent company Alphabet.

But it's not all been plain-sailing for these investor darlings over the past few weeks: the EU has opened up an anti-trust investigation into Amazon (AMZN), while Facebook (FB) has agreed a $5 billion fine for violating privacy rules - it's the largest fine ever imposed by the Federal Trade Commission.

Netflix and chill

Netflix (NFLX) kicked off on a downbeat note. The film and TV streaming service was expected to have added 4.7 million new subscribers over the past three months but only managed 2.8 million. Its share price dropped after the earnings were released but is still up on the year to date from $267 to $335 at the end of July.

Alison Porter, manager of the Janus Henderson Horizon Global Technology fund, says that a second-quarter miss for Netflix is not unusual and believes the company could reach 250 million subscribers in the next five years, from a current level of around 150 million. Porter argues that although Netflix has grown sharply in recent years, it could still grab an ever-larger share of the growing streaming market. Netflix has recently added a smartphone-only version of Netflix in India, for example.

Morningstar analysts remain steadfast in their view that Netflix is overvalued, assigning a $135 fair value estimate to the stock, against a current price of $335. Noting a fall in US subscribers, analyst Neil Macker argues that adding more US subscribers will become harder because of market saturation and competition, noting that Disney is launching a rival streaming service in November.

Apple (AAPL) also has plans to launch a streaming service called TV Plus this autumn, which it hopes will rival Netflix. Apple is trying to diversify away from being dependent on iPhone sales to drive earnings and has seen the enviable success of both Amazon and Netflix’s subscription models.

Apple revenues were up just 1% in the second quarter of the year to $53.8 billion but it forecast a rise of between $61 and $64 billion in the current quarter.

Morningstar analyst Abhinav Davuluri has maintained the fair value estimate of $200 for Apple shares, just below the current price. Davuluri says the launch of the new iPhone model in September will be more low key than previous launches, particularly with consumers holding on for a 5G iPhone in 2020. Sales of the iPhone were down 12 per cent on the year in the most recent quarter but sales of the Mac computer, Apple Watch and iPad were up 11 per cent.

Facebook fine

Facebook’s results were overshadowed by a $5 billion fine but revenues for the social media giant were up 28 per cent on the year, with an 8 per cent rise in daily active users to 1.6 billion.

Morningstar analysts think the shares are fairly valued at $200, just above current levels, but that privacy issues could cast a cloud over the business, while the threat of further regulation will limit the upside for shares in the short term. Facebook’s shares have risen a hefty 48 per cent from $135 to more than $200 this year - close to record highs reached in 2018 before the Cambridge Analytica scandal broke.

In the coming months, the company’s plans to launch its own cryptocurrency, Libra, could be more significant for its long-term potential. Janus Henderson’s Porter believes the significant aspect of Facebook’s foray into digital currency is that it is partnering with more established players like Mastercard and Visa. There is always the possibility that Alphabet and Amazon could move into this space, she adds, once the Libra experiment is tested.

Polar Capital Global Technology fund manager Nick Evans believes that Libra could tackle some of the current concerns over cryptocurrency, namely high volatility and poor governance. “The road ahead with lawmakers is likely to be very challenging, but if successful [Libra] could be a highly disruptive proposition,” he says.

amazon stock

Further than FAANGs

While not one of the FANG stocks, Microsoft (MSFT) goes from strength to strength and its share price hit new record highs during this earnings season; the company has taken back the title of world's most valuable company from Amazon, with a valuation of more than a trillion dollars. 

However, Google parent company Alphabet was one of the biggest winners of earnings seasons, at least in share price terms. The firm beat Wall Street estimates as shares spiked nearly 10 per cent to $1,245, a shade below record highs seen earlier in 2019.

One announcement that particularly excited some investors was that of a $25 billion buyback of Alphabet shares. Porter says that Alphabet is playing catch-up with the likes of Apple, which has been buying back billions of shares for a few years now.

After the latest quarterly results, Morningstar’s Ali maintained his fair value of estimate of $1,300 on the shares. Noting the recent spike in the share price, Mogharabi cautions investors: “We recommend a slightly wider margin of safety before investing in this high uncertainty name.” Still, Alphabet maintains a wide economic moat, which means that it has a strong competitive advantage. This puts in the same company as Facebook and Amazon, but Apple has a “narrow economic moat” or slender competitive advantage.

High expectations

Given the weight of investor expectation on Amazon at the moment, it is perhaps inevitable that missed profit targets in this quarter led to a pullback in the shares. Amazon’s revenues were 20 per cent higher on the year at $63.4 billion was above forecasts, but earnings per share were up 3 per cent at $5.52, below the $5.57 target. Shares fell from $1,986 to $1,930 after the earnings releass, but are still up 20 per cent year to date, a similar gain to that of the S&P 500.

After all, Amazon has beaten Wall Street profit forecasts for five consecutive quarters so it was a hard winning streak to maintain. Looking ahead, the e-commerce giant expects its investment in Prime delivery in the US will put a dent in third-quarter profits; but the company still expects a revenue gain between 17-24 per cent, in line with the quarter just gone.

Morningstar analyst R.J. Hottovy maintains his stance that Amazon shares are undervalued and assigns a $2,300 fair value to the shares: “We still view Amazon as one of the most attractive names in online commerce." He argues that investment in speeding up Prime delivery in the US will weigh on profits in the short-term but will reap rewards in the future. 

The vexed question for investors, one that has been repeated for many years by investors, is whether the tech giants are overvalued. Janus Henderson’s Porter still thinks the sector offers the benefits of a “virtuous circle” – as more investors use their services, whether that’s Google search or Amazon delivery, the more cash these companies can invest in R&D, the more they can innovate and broaden their appeal. She even believes these companies, because of the large amounts of cash held on their balance sheets, have defensive qualities that can withstand an economic slowdown better than more cyclical companies in the US that have higher debt.

Morningstar columnist John Rekenthaler says that the difference between the dotcom boom and now is in the amount of money the top companies make: "The Nasdaq 100 is dominated by companies that are massively profitable. Perhaps those earnings cost too much but there is no question about their ability to make billions of dollars per year."

 

is content editor for Morningstar.co.uk

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