FAANGs are diverging between the haves and the have beens

David Thornton

Livewire Markets

There was a time in big tech when valuations meant next to nothing.

If you wanted growth, big tech was the main show in town and it didn't matter how much you paid for it. 

But those heady days are behind us. In today's rate cycle, valuation and earnings are the name of the game. 

The good news is that not all Big Tech is the same, far from it. 

According to Mary Manning from Alphinity Investment Management, speaking on The Rules of Investing ,the sell off has done two things: it's weeded out the big tech companies with flawed business models, and it's left the good ones at very attractive valuations. 

Messy divorce

There's been a big divergence in the FAANG companies recently, which Manning has seen first hand having met with Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT), and then Netflix at the other end of the spectrum. 

"Meeting with them one on one highlighted the fact these companies aren't on the same trajectory anymore," Manning says.

To understand where they are today, you have to understand where they came from. 

The acronym FAANGs is barely holding together, on multiple levels. 

"FAANGs no longer makes sense at an acronym level - given the subsequent name changes among them - let alone a business level," says Manning. 

"But it also doesn't make sense in terms of why they got the acronym in the first place; you had all these big tech companies that have very high growth and were all trading in the structural growth story in technology."

Then COVID came along and shuffled the pack, artificially pulling forward years of performance for some while others mellowed. An unhealthy sugar hit, you might say. 

"Within the FAANGs you had some companies which were huge beneficiaries of COVID. Netflix (NASDAQ:NFLX) is the poster child there where you had years worth of demand pulled through because of COVID."

Microsoft, by contrast, didn't have the same level of pull-forward. 

The FAANGs have also split along ESG lines. 

Alphinity has never held Meta because its ESG analysis showed the firm is very high risk. 

"If you look at the governance and data privacy of an Apple versus a Facebook, it is absolutely night and day," says Manning.

"Meta was in the dog house from an ESG perspective and that ended up being alpha generative because that led to a lot of problems with Meta." 

Earnings are king

"Within big tech there are a lot of business models that aren't going to make it."

Alphinity follows earnings leadership, which means finding companies that are in a beat and raise cycle.

Crucially, winners like Apple, Microsoft and Alphabet (NASDAQ:GOOGL) have earnings. 

"You have the Meta's and Netflix that were missing users and some of the drivers of earnings, whereas you have companies like Apple (NASDAQ:AAPL) and Microsoft until very recently that regardless of what was going on they were in a beat and raise cycle," Manning says.

"None of these are unprofitable tech companies, and so you can value them on earnings. Alphabet is trading at 20x P/E, and just think about what you're getting for that in terms of the moat and cashflows."

Manning also believes the "tech" label borders on misnomer. 

"Look at Apple. Don't think of it as a tech company, think of it as a consumer company. What you're getting for 26x P/E in terms of the brand and the cashflow."

These companies have the required net cash to put a floor under the stock. If it goes too far south, the companies can buy back shares.  

At the other end of the spectrum are companies where you're buying something on price to revenues and they don't have revenues. 

"18-times would be my line in the sand for Google so long as the earnings are intact. That's a very attractive price," Manning says.

But those at the other end of the scale are what she describes as "pray and hope" investments." 

"They can work in a raging bull market where no one cares about valuation, but in this rising rate environment where people are looking at valuation, there's no downside support for these unprofitable techs."

And this, says Manning, is what's come to be known as "tech wreck 2.0". 

"If you have a company that's trading on 10-15x price to revenues and they're trading at 1000x P/E and it goes down 50%, you're still not at a valuation floor... there's just no floor at all," she says.

Bottom drawer FAANG

At the end of the episode I asked Manning to nominate, hypothetically, the only company she'd own if markets closed for five years. 

Surprise surprise, she chose Apple. 

"If you look over time, int eh last 20 years it has outperformed the benchmark in 18 of those years. So if you're telling me I've got five years, a company that outperforms in up markets and down markets is a pretty good bet," Manning says.

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David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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