What are FAANG shares?

Business Lessons for FAANG, from FAANG — Apple! | by Pratyush ...

On just about every financial website you can find articles about “FAANG shares”. This can be quite confusing for newcomers. What exactly do you think it means?
It’s actually quite simple: The acronym “FAANG” stands for some of the world’s largest and most important technology stocks – the companies that now dominate our daily lives:

  • Facebook (WKN:A1JWVX) – the world’s leading social media company, which also includes Instagram and WhatsApp
  • Apple (WKN:865985) – the company behind the iPhone.
  • Amazon (WKN:906866) – has ushered in the age of e-commerce and built a highly profitable cloud operation.
  • Netflix (WKN:552484) – the most successful video streaming company in the world.
  • Google (WKN:A14Y6F) – but actually this is just the search division of Alphabet.

Why are FAANG shares so important?
Whoever lives in the western world immediately understands why these five shares are so important. Many start the day by looking at the iPhone (Apple) to see what friends and family are up to (Facebook). Or they get the latest news delivered (Google). At the end of the day, a parcel will be waiting for them at the front door (Amazon), and they will be making themselves comfortable inside before their favourite show (Netflix)

It might sound a bit too simplified, but the idea should be clear: These five companies have fundamentally changed our daily lives. Let’s take a look at their omnipresence:

At the end of 2018, there were 2.3 billion active Facebook users per month – one third of the world’s population.
More than half of the people in America have an iPhone.
There are more than 100 million Amazon prime memberships in the United States, and there are an estimated 128 million households.
Nearly one-fifth of all Internet bandwidth in America is used by Netflix.
Google has eight products with more than 1 billion active users: Search, Maps, YouTube, Chrome, Android, Google Play Store, Google Drive and Gmail.
How did the FAANG shares perform?
It’s no wonder that these five shares have performed exceptionally well. Since the end of the last bear market on March 9, 2009, they have been the main drivers of economic growth via the stock market.

At that time, Facebook was not yet a listed company. But the other four were – and their returns have far outperformed the S&P 500 Index. This is how they developed until early 2019:

Performance of FAANGs since 2009 via YCharts

This is an average return of 2,900 % in just one decade. An investment of USD 10,000, evenly distributed among these four shares, would be worth USD 300,000 10 years later. If one had invested in the broader market (the purple graph) instead, one would still have gotten a little more than $50,000.

It can also be said that these four have yielded about 40% per year over the last 10 years. Facebook went public in 2012 and has since then achieved around 25% per year.

Of course, past performance does not mean that this kind of return will continue. But in retrospect, no matter how you look at it, these five stocks have performed exceptionally well.

Today, the total market capitalization of all five stocks is USD 3.2 trillion. That is more than the economic performance of all countries without the USA, China, Japan and Germany.

Which FAANG shares should one own?
Obviously the shareholders of these five shares have achieved enormous returns. But the stock market only thinks about the future, and the important question is: how many of these five shares should one own in order to move forward? Are the best times for growth already behind them? After all, they are already huge.

There is no clear answer to these questions. Every investor has to take into account a wealth of variables: age, lifestyle, risk appetite, and income, and that’s not all. If one thing changes, you might have to rethink everything.

However, in my opinion, the most important factor for any company is the sustainable competitive advantage, the trenches. These trenches come in four varieties:

1 High switching costs: If it would simply be too strenuous, expensive and time-consuming to part with a company.

2 Network effects: With every additional user of a product or service, that product or service becomes more valuable.

3 Low-cost production: When a company can offer a product or service that is at least as good as the competition – but at a lower price.

4 Intangible assets: These include patents, state-regulated protection and brand values.

Let’s start with the world’s largest social media company.

Facebook enjoys a very wide ditch. It consists mainly of network effects. Actually, no company is a better example of the power of the network effect than Facebook. Every additional user of Facebook – or the other brands Instagram, WhatsApp or Messenger – makes the service more valuable. Who wants to be a member of a network where no one else is?

While many are worried about the increased spending on security, I think this will actually be a long-term benefit for Facebook. After all, competing social media networks not only have to offer something that is clearly different from others, but they also have to have enough cash to provide the same level of security. And who has the resources that Facebook has?

Next, we have the world’s most successful designer of a product ever. What the iPhone has achieved in just over a decade is unprecedented.

Apple’s biggest divide is brand equity. In Forbes’ 2018 ranking, Apple had the most valuable brand in the world and was estimated at $182 billion. This can be seen when a new product is launched: people line up for hours in front of Apple stores to get their hands on the next iPhone. No Android device manages to create such hype.

Apple has actually done a good job of digging more trenches. The iCloud and the synchronization of devices make it difficult to switch to the competition. You don’t want to lose all your data just like that.

The company’s App Store also benefits from network effects: As more and more people start buying apps, third-party developers are more likely to create apps on Apple’s platform. But at the end of the day, the brand is the most important thing. Without it, the other parts just don’t work.

This factor is very important. The value of a brand can be volatile. Apple became a myth under Steve Jobs when the company launched completely new products every few years – iPod, iPad and iPhone – products that we didn’t know we actually needed.

Since Jobs’ death, Apple has not delivered a Next Big Thing. So far, it hasn’t fallen on its feet. But the competition is tough, and Apple’s biggest ditch is definitely narrower than that of its FAANG colleagues.

The packages are delivered everywhere. No wonder: It is estimated that half of all e-commerce sales in the United States take place via Amazon.

I personally am convinced of the share – I have no other share in my portfolio with so many shares. And of course this has to do with the fact that the company was able to dig several trenches around itself. Let’s go through them:

High switching costs: Although this is not the most powerful of the four companies, for many customers the deal around Amazon Prime is simply unsurpassed. Free shipping, access to digital content, and a host of other benefits: it’s not easy to find a better deal elsewhere.
Network effects: Amazon is the number one online retailer. The sellers know that. That’s why they list their products on the site and let Amazon do the shipping. This naturally attracts more customers, which in turn attracts more suppliers. The definition of the virtuous cycle.
Intangible assets: The biggest intangible benefit for Amazon is brand equity. Forbes rates it as the fifth most valuable company in the world at just under $71 billion.
Low-cost production: This is where I believe the biggest ditch is to be found. Amazon has a network of 138 distribution centers in the US and another 160 in other countries. This allows products to be delivered to customers faster and at lower costs than the competition could ever hope to deliver.
Another factor that should not be forgotten is the company’s mission. Amazon wants to be the most customer-oriented company in the world.

This is the only way to explain what has become of Amazon since 1997. “An online bookseller has become the world’s largest e-commerce shop and the market leader in computers? Excuse me?” That sounds surprising at first.

But that’s what happens when you have such a big goal. Most people may not even know that the majority of Amazon’s profits actually come from Amazon Web Services (AWS) – not from e-commerce. This part of the business is protected by high switching costs (no one switches so easily from AWS to another provider) and network effects (the more people use AWS, the more data is collected, thus improving AI).

Who knows which industry will turn Amazon upside down next.

Everyone knows Netflix. It’s a little strange that just 10 years ago, streaming was just a test project for Netflix. Back then, DVDs were actually sent by mail. That has been forgotten today.

The trenches of Netflix are not so obvious to the investors, although they benefit greatly from it. The company uses its brand awareness to get customers. There are also considerable drawbacks to switching.

The most important factor in attracting new subscribers is the company’s own content. It’s only available on Netflix, and if you want to see it, you have to pay. And that’s going so well these days that you’re also getting attention at the Oscars.

Added to this are the high switching costs. If you charge the 12 euros or so every month, you hardly notice anything at all. Current users are likely to stick with it as long as there are no sharp price increases or a PR scandal.

But a few things have nothing to do with the company’s ditching. Netflix puts everything on its own content. Since the main goal is to win new customers, this makes perfect sense.

However, this is only the case as long as Netflix continues to produce real hits. So investors don’t just have to look at the balance sheets, they also have to keep an eye on the program.

At the end of 2018, Netflix had a cash position of $3.8 billion, but long-term debt of $10.4 billion. In addition, the company lost $2.85 billion in free cash flow during the year. Of course, that doesn’t last long. That has to change soon if Netflix is to remain a good investment.

Finally, let us come to the group that operates two of the most popular websites in the world: Alphabet. Not surprisingly, Google.com is the number one in terms of traffic. But not everyone knows that Alphabet also owns YouTube.com – the second most popular site.

The average Internet user spends 17 minutes a day on these two sites together. That doesn’t sound like much to begin with. But in the whole year that’s 103 hours – out of billions of Internet users.

For Alphabet, the trench here is low-cost production. What is produced? Data. And in today’s networked world, data is the new oil. As I mentioned earlier, Google has eight products with more than 1 billion active users. Once these tools are up and running, there’s no need to invest too heavily in them. It delivers data at a lower cost. Anyone but Facebook can only dream of such a model.

As a shareholder, you get another advantage: Alphabet invests heavily in so-called moon shots, high-risk experiments that may not produce anything at all – or the next big thing. Only a moonshot has to become something, and the company could achieve an enormous increase in turnover. Waymo, the project for autonomous driving, already looks extremely promising.

But that’s not the only important moonshot. The company is trying to bring the Internet to the most remote areas of the world (Project Loon), ensure cyber security (Chronicle) and enable logistics via autonomous drone (Wing). And that is by far not all.

As an Alphabet shareholder, you can therefore not only enjoy the broad-based data and advertising business, but also the moonshots. This sounds like a very good deal to me.

What are the overall risks for FAANG shares?
You could look at these five companies and think: “These are all technology companies. I don’t wanna put too much money in Tech!”

This view is correct on one hand, but it’s also short-sighted on the other hand. It’s true, all five companies use technology that didn’t exist 25 years ago. But the same is true for almost every other company on the stock market.

Anyone who has reservations about putting too much money into these five shares may perceive them differently:

Alphabet and Facebook are actually advertising companies.
Apple is like a high-end fashion company.
Netflix is an entertainment company.
Amazon is a little bit of everything: retailer, market, logistician and increasingly an advertising company as well.
But you also have to be aware that four of these five are attracting the attention of more and more politicians and regulators. Netflix is the only one of FAANG’s shares not considered a monopoly, but the other four are basically. Apple may seem strange here, but the company’s practices regarding the Apple App Store have already caused a lot of trouble.

You really have to stay vigilant here, even if the opinions of politicians are usually not important for investments at first.

Should you buy FAANG shares now?
All in all, FAANG shares make up a large part of many securities accounts. But does that also mean that you should run right away and put your savings into these shares? I don’t think so.

If you’re interested in FAANG shares, but don’t own any yet, I advise you to enter carefully and buy more little by little. If you choose Amazon, then you can now use about 2% of your deposit on the stock. If you feel comfortable with it, you can buy more little by little.

That may sound like a boring approach. As is well known, waiting is not much fun. But this strategy is also effective, and you don’t get too involved with a share right away.

There is also no guarantee that these companies will not have to give in to the competition at some point. That’s how they themselves became so successful: because they took the market leaders by surprise. And they did that so well that they are now the hunted.

All in all, I think that every investor should carefully weigh up which part of the portfolio you use for FAANG shares. They are all market leaders, and with good reason. They are probably among the best companies the world has ever seen.

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