Over long periods, Wall Street is one of the greatest creators of wealth. But when examined over short time frames, its performance can be hit-and-miss. Whereas stocks were practically unstoppable in 2021, all three major U.S. indexes plunged into a bear market last year. Unless you were heavily invested in energy stocks, there’s a pretty good chance your portfolio has struggled.

When uncertainty and volatility pick up on Wall Street, smart investors have historically turned to the FAANG stocks.

The FAANG stocks are all about outperformance and industry-based dominance
By “FAANG,” I’m referring to:

  • Facebook, which is a subsidiary of Meta Platforms (META)
  • Apple (AAPL)
  • Amazon (AMZN)
  • Netflix (NFLX)
  • Google, which is a subsidiary of Alphabet (GOOGL) (GOOG)

Investors flock to the FAANGs for two key reasons: performance and dominance.

Over the trailing 10-year period (as of May 3, 2023), the benchmark S&P 500 had delivered a very respectable 156% return, not including dividends. By comparison, Apple, Netflix, Amazon, Meta, and Alphabet (Class A shares, GOOGL), have seen their shares respectively appreciate by 952%, 942%, 721%, 718%, and 408% over the same stretch.

The other reason investors are enamored with the FAANGs is their entrenched competitive advantages:

  • Meta Platforms owns four of the most-popular social media assets in the world and attracted 3.81 billion monthly active users across its family of apps during the first quarter.
  • Apple has been named the most-valuable brand in the world by Interbrand for 10 consecutive years, and the iPhone accounts for roughly half of all U.S. smartphone market share.
  • Amazon’s online marketplace was expected to account for just shy of 40% of all U.S. online retail sales in 2022, per eMarketer.
  • Netflix continues to maintain a sizable market share lead in streaming content in the U.S. and internationally.
  • Alphabet’s internet search engine Google has accounted for at least 90% of worldwide monthly search traffic dating back eight years.

However, not even the FAANG stocks are created equally. As we move forward into May, one FAANG stock is more fundamentally attractive than ever before, while another industry leader is priced for perfection in a very imperfect economy.

The one FAANG stock to buy hand over fist in May: Amazon
The FAANG stock that patient investors can confidently buy hand over fist in May is none other than e-commerce behemoth Amazon.

The reason Amazon’s stock has been under pressure since the start of 2022 is the growing expectation that the U.S. economy will dip into a recession. Aside from economic indicators suggesting a recession is likely, the Federal Open Market Committee noted its March meeting minutes that a mild recession has been baked into its outlook for later this year. Recessions are typically bad news for retailers — and Amazon is the king of online retailers.

But there’s a sizable difference between Amazon’s revenue-generating streams and its cash-flow generating channels. Although its online marketplace is its primary source of revenue, it’s a low-margin operating segment that often contributes very little to the company’s cash flow and operating income.

What makes Amazon tick is its trio of ancillary segments: Amazon Web Services (AWS), advertising services, and subscription services. As long as these three divisions continue to grow by a double-digit percentage, sans currency movements, Amazon’s operating cash flow can be expected to march higher. Since Amazon tends to invest most/all of its operating cash flow back into its business, growing its cash flow is paramount to its success.

Cloud infrastructure services segment AWS is, without question, Amazon’s key puzzle piece. Enterprise cloud spending is still in its very early stages, and cloud service margins blow online retail operating margins out of the water. As of the end of 2022, AWS accounted for just shy of a third of global cloud infrastructure service spending, which means it’s leading the charge in this sustainably high-growth trend.

Although advertising is cyclical, it’s nevertheless an important growth driver for Amazon. Thanks to more than 2 billion people visiting Amazon at least once monthly, advertisers are willingly spending to get their message in front of as many eyeballs as possible. Over the trailing six quarters, advertising services revenue, excluding currency movements, has grown by no less than 21% year-over-year.

Lastly, double-digit subscription revenue growth is being driven by Prime. Amazon told investors two years ago that it had signed up more than 200 million Prime members globally. Considering that the company’s online presence continues to grow, and Amazon now holds the exclusive rights to Thursday Night Football, there’s a good chance this membership figure has pushed even higher. Amazon’s subscription segment possesses strong pricing power, which helps to positively influence cash-flow generation.

The icing on the cake for Amazon is that its shares are historically cheap. While Amazon may not look inexpensive using the traditional price-to-earnings ratio, it makes far more sense to examine the company’s price-to-cash-flow ratio given how much of its cash flow it reinvests.

After trading at a median multiple of 30 times its year-end cash flow between 2010 and 2019, investors have the opportunity to buy shares right now for about 10 times consensus cash flow estimates for 2024 and a little over 7 times consensus estimates for 2026. Amazon is a screaming bargain for long-term investors.

The FAANG stock to avoid like the plague in May: Apple
But there are two sides to this coin, and Apple finds itself as the proverbial FAANG stock on the outside looking in.

To clear the air, Apple isn’t a bad company. As noted, it’s considered to be the most-valuable brand in the world by a number of surveys. This is a reflection of its top-notch marketing efforts and the company’s exceptionally loyal customer base. When a new physical product is introduced, Apple’s customers have a tendency to swarm its stores to get their hands on these innovations.

In addition to accounting for roughly half of all smartphone sales in the U.S., CEO Tim Cook is guiding a multiyear transition that’ll see Apple steadily become a platforms company. Focusing on subscription services should expand Apple’s operating margin over time, further enhance customer loyalty to the brand, and minimize the revenue fluctuations that occasionally crop up during the later stages of iPhone replacement cycles.

In other words, Apple is going to be just fine over the very long term. But at this very moment, with the nation’s central bank and other indicators suggesting a recession could be coming, Apple’s stock isn’t all that attractive.

The big tell that Apple could struggle in the short-term occurred in September 2022. The expectation on Wall Street was that Apple was going to increase production of iPhone 14 following its release. With consumers still swapping out 4G-capable smartphones for those with 5G download speeds, Apple was ready to capitalize. However, iPhone 14 sales didn’t launch of the gate as expected, which caused Apple to shelve its plans to boost production of its top-selling device.

As you might imagine, the most-valuable brand in the world is expected to possess strong pricing power. But in spite of higher inflation, Wall Street’s consensus is for Apple’s fiscal 2023 sales (ended Sept. 30, 2023) to decline by nearly 2%, with adjusted earnings per share falling almost 3%.

While neither of these expected declines in sales or profits are particularly large, it is worth noting that Apple’s stock is near a 52-week high in spite of this lack of growth. Paying 28 times forecast earnings for Apple was fine when the company was growing its sales by a low double-digit percentage. However, it makes no sense when sales and earnings are moving in reverse.

Making things a bit more complicated for Apple is the fact that interest rates have risen rapidly over the past year. Apple had, on a few occasions, leaned on cheap capital provided by the debt markets to fund its aggressive share buyback program. Though I would expect share buybacks to continue, the amount Apple is utilizing for share repurchases could slow in the coming quarters. That means less of a boost to the company’s earnings per share.

At 28 times forecast earnings for fiscal 2023 and with no sales or profit growth, Apple is a stock investors can avoid like the plague in May.

— Sean Williams

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Source: The Motley Fool