Big tech US stocks look to prove their worth with latest quarterly earnings

“The aggregate market capitalisation of Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet has grown by 63% or $2.2 trillion over the past 12 months and the latest round of quarterly results, starting with Netflix today, will be the so-called FAANG quintet’s latest chance to show why investors love them so much,” says Russ Mould, AJ Bell Investment Director.

“Of the five, only Alphabet showed a drop in earnings per share in Q2 2020, despite lockdowns worldwide in response to the pandemic, and between them the technology giants increased net income by 16% to $29.6 billion between April and June. Such a strong performance during such an extraordinary time only served to highlight how strong their competitive positions really are and the degree to which their products and services were ideally suited to helping customers work, rest and play during the early stages of the pandemic and initial lockdowns.

“Earnings progress is not expected to be quite so stellar in the second half of the year but shareholders and analysts will doubtless be looking to the five names for positive earnings surprises and forecast upgrades, given their history of beating expectations over time.

Source: Company accounts, Zack’s, NASDAQ, consensus analysts’ forecasts

“It could be argued that forecast upgrades are required if the five stocks are to maintain their stunning run. That $2.2 trillion increase in market cap over the past 12 months dwarfs the combined $8 billion increase in net profit the quintet is expected to generate in 2020.

 
Source: Company accounts, Zack’s, NASDAQ, consensus analysts’ forecasts

“In addition, after a spike that followed Apple’s 4-for-1 stock split at the very end of August the aggregate market cap of the FAANG five has largely paddled sideways and the proportion of the S&P 500’s total market valuation has just dipped back below 20%, although that is still within a fraction of the recent all-time high.

 
Source: Refinitiv data, from date of Facebook listing in May 2012.

“That the US market is so reliant on just five names (or six if you include Microsoft’s $1.7 trillion valuation) may not necessarily be a good thing, all-powerful as they may seem at the moment. The threat of tighter regulation in Europe continues to lurk and perhaps in the USA too, especially if the Democrats achieve a sweep of the Presidency, House of Representatives and the Senate.

“In addition, any earnings disappointment may not be taken well, as their valuations on the face of it offer little downside protection. All five stocks are priced for growth and analysts and investors are unlikely to be pleased should they fail to deliver, for whatever, unexpected reason.

Source: Company accounts, Zack’s, NASDAQ, consensus analysts’ forecasts

“A forward price/earnings ratio of 34.7 times for 2021 means that it would take the FAANG firms almost 35 years to earn their aggregate market valuation, if profits were to come in flat from now onwards.

“Put another way, their 5.5 times combined sales multiple for 2021 means that it would take investors five-and-a-half years to get their money back, if the companies paid out every dollar in sales as a dividend – and that is impossible.

“Clearly, investors are expecting rapid growth, rather than flat profits or sales, this is why it is important for the FAANG names to keep providing earnings upside surprises, even if their investment case does have a less heralded angle to it, namely their financial strength. 

“In the second quarter of 2020 they generated over $26 billion of free cash flow between them, equivalent to 12% of sales, a fifth more than in the same period a year ago and double the sum recorded in Q2 2015. That is not to be sniffed at, especially when many other firms are scrambling around for cash to see them through the pandemic.

 
Source: Company accounts

“Neither Netflix nor Amazon pay dividends or offer share buybacks, but Apple does both and Facebook and Alphabet have a record of consistent buybacks too, supplementing capital gains from their shares with cash returns. Since Q1 2013, with Apple doing the bulk of the heavy lifting, the FAANG names have bought back $415 billion of stock and paid out $94 billion in dividends, for a total cash return of $509 billion, or more than half of their combined market cap when those programmes started.

“If they can keep that up, even the most nervous worrier about valuations could perhaps breathe a little more easily, especially as the FAANG’s combined net cash pile is still $226 billion, even after operational and financial leases are taken into account.”

APPENDIX: Quarterly reporting schedule for the FAANG stocks
Tuesday 20 October: Netflix Q3
Monday 26 October: Alphabet Q3
Thursday 29 October: Apple Q4
Thursday 29 October: Facebook Q3
Thursday 29 October: Amazon Q3