Netflix (NFLX) has been fighting hard to get out from under some negative sentiment surrounding its second quarter earnings. The sudden fallout yesterday showcased the main problem with tech stocks. Many of them are so overvalued relative to earnings. Because of that, any notion that future earnings potential might not live up to the hype can be detrimental to stock prices. Regarding tech and FANG stocks, I think it's best to start looking at things from a value perspective. That's the only way to avoid these panic runs being induced when Wall Street wakes up to the fact that paying 200 times a stock's worth is a little bit risky.
Of the FANG stocks, Facebook (FB) is the most compelling investment case to me. Facebook and Alphabet (GOOGL) offer the most realistic valuations in their stock prices; and Facebook offers the clearest path to continued earnings growth at the present time. The revenue/earnings bumps that occurred even after that huge dramatic data scandal show that consumers are relatively undaunted by the prospect of sacrificing their personal privacy for superfluous social media entertainment. In a way, this should terrify us. At the same time, it sure does put investors at ease.
If you take a look at the past/forecasted annual earnings among the FANG stocks, it's clear that Alphabet is the bread and butter, while Amazon (AMZN) seems the most primed to drive their growth position over the next year and a half. But when you look at the earnings relative to each stock's current valuations, it's clear that Facebook is the best value buy.
If full year forecasts for 2018 and 2019 hold true, Facebook will have a 5-year earnings growth rate that far exceeds Alphabet; while current stock pricing keeps the social media company right in line with Alphabet in terms of forward P/E ratios.
Amazon and Netflix both have incredible earnings growth rates ahead of them, but in terms of pricing, it just doesn't compare. Even if Amazon hits 2018 forecasts, the stock is still trading 146 times higher than those potential earnings. Netflix has a comparable valuation issue. From an earnings perspective, Facebook might make much less, but the value to shareholders is much more meaningful.
It's all about Instagram
Though Facebook's total user growth was the lowest it has ever been in Q4'17, things rallied in the first quarter this year; increasing daily active users by 3.42%. With that rally came just under $12 billion in revenue. When you consider how this coincided with all of the flak the company was taking over its data issues, it's clear that Facebook's user base is relatively safe. That said, Facebook's growth story right now isn't from Facebook. It's the billion people that have joined Instagram.
Nearly half the size of Facebook, the Instagram acquisition is probably the greatest move that any business has made in the last decade. By getting their hands on Instagram, Facebook virtually stopped Snap's (SNAP) Snapchat app in its tracks by providing an comparable, if not better, substitute good. With 5% growth per quarter, Instagram seems primed to keep climbing. It's not outrageous to say that the app could hit 2 billion, maybe even surpassing Facebook in total users. The appeal is the simplicity. It's pictures, a comment, and the addictive ability to scroll through your feed.
This growing user base means that Facebook has even more marketing ability at its disposal. Even with the Facebook app receiving less love than it used to from younger individuals, I see a growth story here in relation to Instagram. As long as Facebook doesn't decline, the overall ad revenue story for the combined company should be pretty darn positive.
Long term, anyone who holds these FANG stocks will likely get burned. Let's face it, Netflix is being copied by others. Amazon will not conquer the entire retail sector. That's called a monopoly. The United States doesn't allow those. Furthermore, it runs on pretty thin margins. Google has a powerful position of strength, but the growth story is becoming that of a mature company; slower. Facebook is the FANG stock that has some bite left in it due to the value, relative to potential earnings growth. Because it's more fairly priced, the stock can react positively to good earnings results in a way that expensive stocks like Netflix just can't do. And if things go sour, there's a lot less for Facebook to lose.