Sky-High Faang’s actions were never just bargains
(Bloomberg) – What explains the bull market’s ability to recover despite valuations that overshadow anything other than the dot-com bubble? Everything from passive investing to buyouts is hinted at to explain it, but the real reason is the bizarre predictability of the corporate profit machine in America.
Patience is rewarded like no other time. With profits rising as steadily as they are steep, nosebleed valuations are proving to be very reasonable compared to earnings a year or two later. Call it a retrospective P / E – the price divided by the profits that eventually materialize.
The result was a rally which, although paling next to the late 1990s in terms of hysteria, caught up in terms of duration. Every year the bears are more and more convinced that the stock market is going to collapse due to its high valuation. And every year this is not the case.
Concrete example: the block of companies with technological mega-capitalization known under the name of Faang. Their formidable ability to quickly increase their profits challenged Cassandras who said buying Faang stock for more than 30 times the profits would haunt investors.
“At the end of the day, everything has to compromise between fundamentals,” said Eric Marshall, portfolio manager at Hodges Capital Management. “These Faang stocks are valued as they are because they are disruptors – they’ve changed the way people shop, they’ve changed the way people work, they’ve changed the way people consume the media. “
Take Facebook Inc. in 2013, for example. The stock looked very expensive a year after its debut, hitting a price-earnings ratio of 62 based on the revenue it generated in the previous 12 months. However, compared to the profit the social media company made a year later, the action is only half the price.
Amazon.com Inc. has shown a similar story. The internet giant was trading at around 183 times its reported profits at the time. Judging by the profits that materialized five years later, it was cheap – for a multiple of 14.
Needless to say, that year marked the start of a 530% rally for the Faangs – Facebook, Apple Inc., Amazon, Microsoft Corp. and Google’s parent company Alphabet Inc., a move that easily overshadows all of the major industries in the S&P 500. Faang’s original member Netflix Inc. has gained more than 1,000% since then.
Bubble warnings were heard again when the broader market began to recover from the pandemic lows of 2020. Yet corporate profits have risen so dramatically that these valuations, when analyzed against real earnings published a year later were nearly 20% cheaper than analysts expected.
Valuations are never great tools for market timing, but they matter in the long run, because the more overvalued the market, the lower its future returns. According to a study by Deutsche Bank AG, valuations similar to today’s have historically generated slightly negative returns on average over the next five years.
For Binky Chadha, chief strategist at Deutsche Bank, the current stretched multiples reflect confusion over the exact position of the market in the earnings cycle. With S&P 500 companies beating analysts’ estimates by more than 15% for five straight quarters, stocks are valued for a prolonged rally and for the big beats to continue, he says. However, incomes are already 10% above the trend observed in recent decades.
“With the current cycle moving very quickly, the risk that remediation will be difficult increases,” Chadha wrote in a client note.
Of course, there’s no guarantee that the high expectations inherent in stock prices will come true, not even for the biggest companies. As some of the Faang just saw a resurgence in consumer and business spending to hit a quarter of record profits, Apple warned that sales growth could slow amid tight supply and Alphabet said it was too early to predict longer-term trends due to pandemic uncertainty.
Not to mention the increased regulatory control these behemoths face. Apple shares fell more than 3% on Friday after the iPhone maker was ordered by a court to allow developers to direct consumers to external payment methods for mobile apps.
The big bulls of technology are not discouraged. Faang shares rose 8% this quarter, joining defensive stocks like utilities as market leaders. While some say this is driven by the desire for stable businesses amid heightened macroeconomic uncertainty, it would be remiss to attribute all of this to a rush for security.
With the exception of Amazon, the rest of the Faang have all seen their earnings estimates rise, surging an average of 13% over the past three months. This compares to a 7.5% increase for the S&P 500.
Anyone who looked at the rating warnings was right. The Faangs have added $ 8 trillion in stock value since 2013, buoyed by uninterrupted earnings expansion that suffered from the 2014-2015 oil shock and the pandemic recession of last year.
And analysts’ estimates suggest that the strength of Faang Block’s top earnings will continue, increasing at an annualized rate of 23% over the next three to five years, double the expected growth rate of the S&P 500.
“Their business models appear to be almost bulletproof,” said Mike Mullaney, director of global market research at Boston Partners. “I’m more willing to pay for this.”
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