Enjoy these stocks if you own them; tread carefully if you don’t
This article looks at some of the valuation metrics of the infamous FAMAG stocks – Facebook (now Meta Platforms), Apple, Microsoft, Amazon and Google (Alphabet) – as well as four other tech-oriented large cap stocks (Tesla, NVIDIA, Shopify and Netflix) that have enjoyed strong appreciation in their shares since pandemic lows, and some especially in just the last five weeks. Whilst the S&P 500 has rocketed forward 9.1% since the end of September, five of these nine stocks have exceeded this return, none more significantly than TSLA (+57.6%) and NVDA (+43.6%). As you can see in
the table to the right (companies are ranked by return since Sept 30, 2021), there is a middle-tier of three companies – two FAMAG and one non-FAMAG – that have also beat the S&P 500. The remaining four companies, of which three are FAMAG companies, have returned less than the S&P 500 over this short period, with FB being the worst performer.
With this recent sharp appreciation as context, the purpose of this article is to look more closely at this group of nine very strong companies and to see how investors are valuing them using metrics like revenues, revenue growth, net income and total assets. More and more, this sort of approach admittedly feels “old school” because it involves looking at company fundamentals to determine value. Perhaps some of my readers remember when this used to matter. Today, we find ourselves in a different environment altogether, one in which prices of stocks are not always strongly correlated either with underlying company fundamentals or, just as likely, have valuations that make no sense when compared to other companies in the same industry. We find ourselves here at the moment because this is a period of nearly free money thanks to the accommodative policies of the Federal Reserve, which encourage risk taking and the use of leverage via margin and options. Investors continue to pile into momentum favourites which pushes them higher and higher, encouraging other buyers to invest just because the stock prices keep going up. If you are not holding at least some of these mega-tech names in your portfolio today, it is almost certain you would be underperforming benchmark indices because the FAMAG (plus NVDA and TSLA) stocks are so dominant in the indices. It is impossible to say what will eventually end this crazy mindset focused on momentum, but history has shown time and time again that it will eventually end. Perhaps the catalyst will be a central bank mistake, or it will be an asset bubble bursting leading to systemic risk. Or who knows – it most likely will be something we aren’t even focused on or are aware of today, a so-called “Black Swan event” (similar for example to the current pandemic).
Let’s take a look at a few tables I put together that examine valuations of these nine companies, all market darlings and have performed extraordinarily well, and all of which are bottom-line profitable. The FAMAG companies are in blue and the non-FAMAG companies are in red in all of the tables.
Table 1 to the left presents these companies ranked by market capitalisation using closing stock prices on Friday, November 5th. Five of the companies – MSFT, AAPL, GOOG, AMZN and TSLA – have market capitalisations over $1 trillion. With its recent surge in its share price (+57.6% in five weeks since Oct 1st, from $775.22/sh to $1,222.09/sh), TSLA now has a market cap of equity that is larger than Facebook, in fact rather materially. And NVDA – up 43.4% over the same period (from $207.42/sh to $297.52/sh) – is chasing FB, too. Including both Alphabet classes of shares, the five FAMAG stocks, TSLA and NVDA collectively account for around 25% of the S&P 500 index. For reference, NFLX is the 20th largest company in the S&P 500, and SHOP – not in the S&P 500 because it is foreign (Canadian) – would be ranked around 43rdor 44th, about the same size as McDonalds.
Table 2 will give you an idea of the revenues and net income of these nine companies. I have also included the companies’ net income margins to give you a sense of their profitability. The companies are ordered from largest absolute net income to smallest in the table.
As far as revenues, the smallest FAMAG is Facebook ($112.3 bln). Still, the revenues of FB are more than those of NVDA, NFLX, TSLA and SHOP combined ($101.6 bln). The smallest FAMAG by net earnings (LTM) is Amazon ($26.3 bln), which – similar to the revenue perspective – still has profits that are more than the combined profits of the four non-FAMAG companies (NVDA, NFLX, TSLA and SHOP) combined ($19 bln). If you are scratching your head over valuations, it is only going to get more interesting, or perhaps confusing, depending on your perspective!
Table 3 below looks at the relative market value of these nine companies compared to their trailing (LFQ) revenues and bottom-line net income. The companies are ordered from the lowest multiple of earnings (the P/E ratio) to the highest. As you will see in the footnote to the chart, I have used adjusted net income for SHOP.
The four non-FAMAG companies have average revenue multiples that are more than three times the FAMAG companies, and average bottom-line multiples (trailing P/E ratios) that are over five times the average of the FAMAG companies. One explanation often touted is that the FAMAG stocks are so big their growth cannot be nearly as strong (from a percentage perspective) as that of the “smaller” companies like TSLA, NVDA, SHOP and NFLX. Another is that the non-FAMAG companies have delivered substantially higher revenue growth and because of operating leverage, their profitability will increase even faster, justifying the nose-bleed P/E multiples. All nine of these companies are well positioned from a competitive perspective and have strong management teams, so the difference can’t really be wholly attributed to “soft attributes”. That leaves me with no real explanation except momentum investors indiscriminately piling into some of these stocks pushing multiples to ridiculous levels, apparently oblivious to intrinsic value.
I am not an investor that pays much attention to balance sheets aside from cash (liquidity) and debt, because the value of assets is at historical cost (less depreciation), which over time can drift a long way from the real market value of assets. Still, I like to look at ratios of market cap to total assets and market cap to book value of equity because there is information in this data as far as relative value, all else equal. Table 4 below lists total assets and book value of the nine companies, ranked from largest to smallest by total assets. I have also included market valuations vis-à-vis total assets and book value in the two rightmost columns, to give you a sense of their relative market valuation vis-à-vis these balance sheet figures.
The five FAMAG stocks are the largest by far by total assets. The smallest FAMAG as far as assets (AAPL) has almost three times the total assets of the largest non-FAMAG company (NVDA) on this list. There is also a rather significant difference in book value between the FAMAG and non-FAMAG names. Again, TSLA and NVDA stand out – perhaps not surprisingly given their recent run – because both companies are trading at levels substantially in excess of their total book assets (20.9x – 25.8x) and book value (44x – 44.7x). One other interesting thing to note is that within the non-FAMAG stocks, NFLX appears to be the most reasonably valued on the basis of total assets and book value, valuation metrics which make it more akin to the FAMAG stocks than to names like SHOP, TSLA and NVDA.
I mentioned already that some investors feel that the higher multiples associated with some of the non-FAMAG names can be attributed to their faster growth rates. This is fair enough, so I put together two additional tables. The first one (Table 5) ranks the companies by the 5-year historical growth rate of their revenues, for the period from 2016 to LFQ of 2021.
As this table illustrates, it is true that the faster growing companies as far as revenues – namely SHOP, TSLA and NVDA – are the ones with higher valuation multiples, which one can say have been earned by their exceptionally strong growth in revenues. Again, NFLX is somewhat of an outlier, finding itself amongst the FAMAG names. SHOP had a loss in 2016 so has been excluded from this calculation. You can see that the growth rate of FB is only 2% below that of NVDIA over the last five years, although FB commands substantially lower valuation multiples. Table 5 also includes two credit metrics, one of which is cash (which is a gauge of liquidity) and the other of which are each company’s credit ratings (a gauge of access to the debt capital markets). As the table shows, the FAMAG companies have substantially higher amounts of cash and stronger credit ratings that the non-FAMAG companies. FB and SHOP are not rated because neither have used the bond market (ignoring SHOP’s convertible bond). NVDA has a strong investment grade rating, just a touch below AMZN (weakest of the FAMAG stocks) but certainly strong enough to offer the company ready access to the debt capital markets for funding.
The final table (Table 6) revisits valuation multiples once more but puts these multiples in the context of projectedearnings for the coming year. I have also included analyst consensus’ revenue growth for next year (2022) in the final column. The companies are ranked in Table 6 by their forward P/E from the lowest to the highest.
Perhaps not surprisingly if you have been following the valuation figures so far, the FAMAG names are the cheapest stocks when looking at forward P/E. The difference in trailing and forward P/E for each company also reflects the growth rate in earnings. In this respect, you can see that TSLA, NVDA and AMZN provide the best pick-up, with TSLA leading the pack. Still the forward P/E multiples cause me to think that MSFT, AMZN, NFLX, NVDA, TSLA and SHOP are all expensive relative to most S&P 500 companies. As far as expected revenue growth in the coming year, TSLA and SHOP are expected to be the fastest growing companies. (You will not that SHOP’s P/E ratios are unusually high, and perhaps not directly comparable, because I used adjusted net income, which excludes nonrecurring income related to gains on sales of equities and other investments.)
Qualitative and other equally important metrics aside, these figures cause me to conclude that the FAMAG stocks are far from cheap, and the non-FAMAG stocks are ridiculously over-priced at these levels. It is momentum, not performance, that is taking some of these stocks to rather absurd levels by any traditional metric that an investor wants to use. However, as I said at the onset, this doesn’t matter at the moment because the market is driven by momentum. If you hold any of these stocks, it is hard to part with them because they have delivered amazing performance over time and remain highly coveted even though they are divorced from intrinsic value. This simply doesn’t matter in a market like we are in currently, although rest assured that it will one day. I’m not sure I would buy any of these stocks at these levels if I didn’t already hold a few, with the possible exception of FB, which seems to be by most metrics the (relatively speaking) cheapest of the lot.
Disclaimer: I own directly or indirectly several of the stocks mentioned in this article, including MSFT, AAPL, AMZN, GOOG, FB and SHOP.