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Sound Advice: November 17, 2021

FAANGs? 

No, that’s not a typo.  It’s about the ongoing disparity between overall market returns and the price action of a few large tech companies for nearly a decade.  Until recently, FAANG stood for Facebook, Amazon, Apple, Netflix, and Google. Although Google renamed itself Alphabet and Facebook morphed into Metaverse, current conversations continue to speak of them as before.

A distant cousin of the FAANGs emerged almost a half century ago.  That cousin was known as the Nifty Fifty, which included such names as General Electric, Coca-Cola, and IBM.  The Nifty Fifty group also included Xerox, Polaroid, and Eastman Kodak.  What the FAANGs have in common with their ancestors is extraordinarily high price-earnings ratios (i.e., valuations). 

These were referred to as one-decision stocks. Wharton professor Jeremy Siegel suggested that investors could buy them and hold forever, but that suggestion didn’t turn out well.  The extreme bear market of the early 1970s crushed valuations across the board.  At the market bottom, the price-earnings ratio of the Standard & Poor’s 500 Index fell into the high single digits, compared to more than twice that today.

Some of the companies survived, but for most the picture, if there is one, was not pretty.  Polaroid and Eastman Kodak are ghosts.  Xerox is no longer the dominant name in copiers. GE is in the process of splitting into three parts. IBM and Coca Cola, however, remain healthy, but significantly changed from their prior selves.

Which brings us back to the FAANGs’ continuing distortion of current market valuations, which are near the top end of their historic range.  Excluding the FAANGs, market valuations would be about 10% lower. That may be viewed as reasonable as long as interest rates remain in the low range that has prevailed for more than 10 years.

Going forward, however, there are risks.  One is the pace of future growth.  For all of these companies, prospects are viewed as unusually bright.  Here and there, a brief misstep may not be an issue, but any that don’t maintain their recent growth pace will see their valuations markedly squeezed.  What’s more, a significant uptick in prevailing interest rates will put pressure on overall stock valuations.

The former is always a distinct possibility.  The latter is a probability. 

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

203-222-9370

www.soundasset.com

www.soundasset.blogspot.com

 

Any questions?  Please contact me at nrwayne@soundasset.com

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