The recent underperformance of the so-called “FAANG” stocks has led some investors to question whether a strategy of owning these large technology companies remains sound, namely, Facebook (now called Meta Platforms), Amazon.com, Apple, Netflix, and Google (now called Alphabet). For full disclosure, clients of Baskin Wealth Management currently own shares of all these companies except for Meta Platforms, which we sold earlier this year.
The FAANG acronym originated in 2013 with popular CNBC host Jim Cramer identifying 4 companies: Facebook, Amazon, Netflix, and Google, that were dominating their respective industries. Over time, additional companies such as Apple and Microsoft were added to the name. Today, each of these companies are far more dominant than what anyone would have expected:
- Meta, Alphabet, and Amazon control 74% of the digital ad market and nearly half of the entire advertising market.
- Amazon controls 57% of all e-commerce sales.
- Netflix controls nearly half of the streaming market and has changed the way movies and shows are viewed and made.
- Amazon Web Services, Microsoft Azure, and Google Cloud have 65% of the fast-growing cloud infrastructure market.
- Apple and Google’s Android have 98% market share mobile ecosystem.
The reason for their continued strong growth is the superior nature of digital advertising, video streaming, e-commerce, mobile, and cloud infrastructure over incumbent “old-economy” competitors and we see little reason why trends will not continue into the next decade. Despite a weak economic outlook, all these companies are expected to report record revenues for 2023 even considering the strong US Dollar.
Nor has this come at the expense of profits: due to their significant economies of scale, these 6 companies are some of the most profitable in history with a combined US$280 billion in profits over the last year. To be sure, these companies (like everyone else) splurged over the last two years on capacity and headcount, leading to concerns about declining margins, but all of them should remain solidly profitable under any scenario, especially as the CEOs of these companies have committed to pulling back spending and maintaining margins.
This differentiation will be critical going into an environment where funding is no longer cheap. Unprofitable would-be competitors will be forced to pull back on spending, and customers will be more focused on value over performance by choosing products like Microsoft Teams over Zoom. As Netflix’s management noted in their most recent shareholder letter:
“It’s hard to build a large and profitable streaming business – (all of our) competitors are losing money on streaming with aggregate annual direct operating losses this year that could be well in excess of $10 billion, compared with our +$5-$6 billion of annual operating profit.
While it’s early days, we’re starting to see an increased profit focus (from our competitors) with some raising prices for their streaming services, some reigning in content spending, and some retrenching around traditional operating models which may dilute their direct-to-consumer offering”
Although growth rates will slow down, we expect a weak economy and high inflation to be a net positive in the long run for big tech, which will be able to continue investing even as their competitors pull back.
To be sure, there are risks. No company is immune to a deep, prolonged recession, and a sharp contraction in the economy would flow through to the financial results. Furthermore, the continued success of these companies over smaller competitors has led to many fines and ongoing antitrust investigations over their business practices around the world. However, with large technology stocks trading at near-market multiples despite having superior growth prospects and strong balance sheets, we think prospective long term returns look attractive.