In this bonus episode of Wealthy Behavior, Sammy talks to Heritage Financial’s Chief Investment Officer, Bob Weisse, about the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google). Most investors hold these stocks whether they realize it or not. Tune in to hear Bob’s thoughts on why the stocks are suffering right now, which of the FAANG stocks are expensive or cheap, what the longer-term outlook is like for these companies, and how investors should think about these popular stocks as part of a diversified portfolio.
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Welcome to Wealthy Behavior, talking money and wealth with Heritage Financial. The podcast that digs into topics strategies and behaviors that help busy successful people build and protect their personal wealth. I’m your host, Sammy Azzouz president of Heritage Financial, a Boston based wealth management firm working with business owners, executives and retirees for more than 25 years. Now, let’s talk about the wealthy behaviors that are key to a rich life.
Welcome to a bonus episode of the wealthy behavior podcast. I’m your host, Sammy Azzouz, and from time to time, our chief investment officer Bob Weiss and I are going to sit down and talk about something going on in the investment world that’s particularly timely interesting or on an individual investor’s minds right now. And today we’re going to talk about the so called FAANG Stocks: Facebook, Apple, Amazon, Netflix, Google, stocks that a lot of people pay attention to because they’re the mega cap growth companies that we use every day. They had a strong stretch of absolutely crushing the market really between 2016 and late last year, earning on average more than double the market returns. And because of that, because of the attention that they got and the performance that they’ve had, they’ve become a big part of portfolios, either because investors loaded up on them by buying them individually in their brokerage accounts, or they’re just naturally a big part of a lot of mutual funds and ETFs. But lately, it’s been a different story. This year, there are underperforming the market. And for some, it’s quite ugly. Netflix is down about 70%. Facebook, which is really now Meta, down almost 40%, Amazon, down 25%, so bob, you know, when you look at these names, what jumps out at you? Yeah, so a couple of things that they are great companies to start their household names. And good companies, for the most part, quite profitable, as far as investing and looking at stocks that there’s two problems. One is valuations, and that’s taken care of itself. As you said, Sammy, Netflix, which was the most expensive one being down 70%. That’s the way to fix your valuation. You may not recoup that though, too quickly. So that’s kind of a permanent fix. But a different problem is size. And you can basically only get so big. So some of these companies like Facebook started off small and now they basically dominate the world in their market. And it’s tough to keep growing from there. So when you unpack that a little bit and talk about valuations, explain that a little bit to the average investor, what their valuations are, maybe not necessarily stock by stock, but just in general, how much more expensive they are than the market and how you’re measuring that. Yeah, so a common way to look at valuations is the price to earnings ratio. And there were times, not so long ago when Netflix has an example traded over 100 times earnings. So let me pay in over $100 for a dollar of earnings. And that just doesn’t make sense. It’s not sustainable unless you think that that dollar is going to grow from $2 to $4, $8 to $16. And then it starts to make sense. And eventually like, Netflix, their growth rates slow down. And investors said, you know what? I think 20 times earnings closer to the market average is about what a company like that should go for because they have competition. Look at all the options you have in streaming services today like Disney. And all of a sudden, it switched from this high growth stock that is going to be we’re going to spend all of our time on Netflix in the future to just another company that has to trade along with fundamentals like the rest of the market does. So that’s a big part of this and it’s kind of the thesis for these stocks and for growth stocks in general is basically I know they’re extremely expensive, but I’m willing to pay a lot for them because basically they’re going to take over the world or their slice of the world and you’re willing to pay astronomical earnings because you think basically eventually Netflix is going to be the number one content king in town. I am just using them as an example. And then when they disappoint the market gets really frustrated, the thesis breaks and they get into the penalty box for a while and basically Netflix, I think they just said they lost subscribers. Maybe for the first time, 200,000 subscribers with what you’re talking about. There’s so many different streaming options. So the stock sold up. And that’s I think a typical thing with growth investing. It’s great until the market gets disappointed or starts to see signals that you’re not going to continue to grow at this phenomenal rate that they’ve been really overpaying for. Yeah, that’s exactly right. And there are winners and losers in the FAANG’s. You take the FAANG acronym, Netflix has always been the smallest of the bunch. Right now, their market cap is around 90 billion.
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Apple’s close to 2.7 trillion. So apple’s 30 times the size of Netflix. It was a hot stock. Now that it’s down 70%, admit the case that Netflix should probably be booted from the FAANG acronym. I recently heard, I think Jim Cramer said that the new name should be the mama stocks and he’s taking what is it meta Apple, Microsoft, that got left out from the very beginning, you know, poor Microsoft, they’re a big tech company. I’ve been the largest and never made it because it doesn’t cutely fit in FAANG. And then you’ve got alphabet, not Google anymore. And apple. So the acronym can shift around. But over time, it just shows how markets change companies change. Yeah, absolutely. And I was looking at that kind of disappointment of earnings. I know Amazon came out recently with disappointing earnings. The stock got hit harder. I don’t think Apple has disappointed as much. I think it’s holding up a little bit better. And I know Facebook or meta, which is still such a goofy name transition. But hurting last year, I think, with the Apple iOS change that to kind of security that they felt was going to hurt their revenue, but today, or I think yesterday they came out with earnings that were a positive surprise and so the market responded well. So a lot of it is a reaction to the growth rate to the expectations. That’s on the valuation side. You talked about something else though, which is, I think, I don’t want to gloss over, which is basically look at some point you’re just so big, you’re not going to be able to maintain that growth rate, whether or not people love the trajectory that you’ve been on. Yeah. So with science there’s two things. There’s the business can only get so big. The economy is only so big. And then the stock market, you can only be such a big part of the stock market. So taking the first point, if you look at Facebook and their earnings that came out this week, they had these numbers that boggle in my mind every time I hear them. About 263 million active monthly users in the U.S. and Canada, 263 million. The population of the U.S. and Canada is about 368 million. So something like two thirds of the population of the U.S. and Canada is on Facebook. Monthly. And you have to be 13 years old to be on Facebook. So you take out that demographic. My wife’s 99 year old great aunt. I can tell you isn’t on Facebook. So when you adjust for people who are actively connected to technology, there’s only so much more room to grow. And I think ad revenue was down. So per user. So you’ve kind of got there. They were smaller, but they’ve climbed them out and they have all the users. And how do you grow from there? Well, maybe that’s where meta comes in and Mark Zuckerberg’s trying to invent a whole new world as the next avenue of growth for Facebook. Yeah, and I think they pick up a lot of new users from the Instagram acquisition. But again, that becomes mature and it’s worth pointing out. I think Facebook or meta makes $10 billion a quarter or something like that. So it’s a phenomenal business, but if the market has been paying a lot for that share of earnings and is overpaying for it and just doesn’t think that the growth rate will be there. They’re going to take a hit, which is what we’re seeing. So when you contrast that, Bob, with another style of investing that I think you and I are a little bit more comfortable with, which is taking a value based approach to portfolio management, how maybe using some of these stocks as an example or a different stock. How does that look and why are both kind of important to bake into a portfolio? Yeah, it just continuing on with the Facebook meta example. That stock’s down trading around 15 times earnings now, which is actually a little cheap, cheaper than the market. So when you think of it that way as a value investor, okay, they’re trading at 15 times earnings market cap. I think it’s around 500 billion there buying back about 30 billion in shares. So I think it works out to 6 to 7% of their shares there buying back each year right away. That’s a pretty good return to investors. So you’re able to start to do the math and find it from the bottom up fundamental standpoint, a good investment when they’re trying to net 30 plus times earnings and not buying back shares. It’s expensive, but it’s gone from expensive growth stock. So you lose 50% and all of a sudden, it’s a value stock and it starts to look attractive based on the amount of cash that there aren’t. That pivot can take a while though, right? I mean, I remember, I mean, I don’t know if this is enough to draw conclusions from because it’s one investment environment, but the tech names that were the darlings and the late 90s, early 2000s, the ones that survived and were good businesses like a Microsoft.
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Were eventually cheap or much cheaper, but there wasn’t this immediate switch where investors gravitated toward them because now their value stocks. I feel like investors were frustrated at the fall from the kind of growth rates and it took a long time. I think it was dead money for a long time before some of those profitable technology companies started to become considered cheap enough to attract investor attention under a so called value approach. Yeah, these things definitely take time to sort out. And with investing, what’s kind of frustrated for value investors is there’s a lot more to invest in than valuations. And a big part of it is emotions, human behavior, and when you see something like investors who have owned Facebook on Facebook, I’ll stop talking about Facebook, say this tech stocks that have gone down a lot. You have frequently what’s called momentum or trend following and people throw in the towel. This thing stinks or I’ve made enough money and they sell. And that process takes time until it’s no longer the FAANG stock, the place you want to be as a constraint, it contrarian, and it’ll turn to the stocks, they’re dead, you know, pessimism. I don’t want to touch those. Those things that they had to run and it’s over. That’s when you might want to start to look at them and I don’t think we’re there yet. Yeah, I did want you to touch on that, that basically, you know, we’ve seen in some of the managers we work with, believe in this, that basically there’s not this immediate switch. You get a sell off and all of a sudden people are excited and they jump back in and you start to recoup your money when things sell off. They tend to go in that direction for longer than you would think. And when things are going up, they tend to go in that direction for longer than you think there is momentum. I don’t know whether it’s because people initially under react to the news and then eventually overreact to it, which is one theory, but it does take time for that to shake out once you start moving in that direction. Exactly. Yeah, you don’t go from an expensive to fair value back to expensive. You do overshoot generally with all assets. And you might be getting moderately attractive now, but definitely somewhere thanks to shake out with those companies. So this is why you’ve seen basically the NASDAQ and large cap growth in the U.S. struggle more than the overall market this year and value because these names were just such a big part of those constituent indices. Yeah, that’s definitely a big part of it. I looked at a composite of the FAANG Stocks. And I think they’re down about 35 to 40% from last November. And the S&P is down about 7%. And if you adjust for them being 20 plus percent or so, the S&P, the math works out almost to S&P companies banks are flat while the banks are down 35% or so since November. Can you explain how that works a little bit? I think people might find that maybe new information or helpful information when you look at the index when you look at the market, if you think you’re a passive investor in the S&P 500, what ends up happening is as these stocks do well, you end up owning a lot more than them and maybe getting a little bit more concentrated in one area. So explain a little bit about how the S&P is built and how market cap changes can kind of distort the allocation. So S&P 500, it’s an index. It’s market cap weighted. So the larger the company, the larger the position. So if you have a company that’s a $1 trillion, $1 trillion market cap. So market cap share price, times, shares outstanding. And when companies are $1 trillion, one company is a $100 billion, you’ll have ten X weight in the $1 trillion company over the $100 billion company. So as companies go up in price, they become more expensive as they become more expensive, they become a larger portion of the index. So when you look at these bank stocks, now that they’ve performed so well over the last few years, they’re a big portion of the index. So it’s about 20% of the S&P is in a handful of companies. And looking at the largest one, it’s Apple. So Apple is 7% of the S&P 500. And it’s had phenomenal returns. $2.7 trillion market cap, but if you buy an S&P 500 Index fund, you’re put in 7% of your money at Apple. So that’s just a little bit of how they work. Does that make sense? Any questions on that? No, no, absolutely. That makes sense. And I think that’s why it’s relevant to investors, whether they realize it or not. If you index funds, if you own ETFs, if you want to target date funds in your 401k, you’re going to have a very healthy amount, maybe too healthy if that’s a term that makes sense of exposure to these names.
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So paying attention to them, even though you may get them through a commingled vehicle and understanding what’s going on with them is important. Yeah, and that’s where diversification is key. And we look at it not just in U.S. equity. Some people might say, S&P 500 and done, I’m getting 500 stocks. But when we invest across market cap in the U.S., a large company is mid company, small companies, till towards value, but then also invest overseas international markets, emerging markets, at real estate, broad assets. You get a broadly diversified portfolio. And you end up with a FAANG stocks in there, but a much lower weight than 7%. So you should own them, but there’s a lot of other good assets in the world. I know we don’t do individual stocks. We definitely have a more diversified approach, but are there stocks that concern you more than others or that you find more attractive than others? So I guess I have probably hit the concerning ones, Netflix, in particular. Amazon’s looks expensive as I just anchor on valuation. So on the positive side, Facebook valuation is starting to get better. And apple is an interesting one. Apple does trade at a premium to the market. But that company has held in there. They’re making a ton of cash, raising their dividend, and you never know. It’s been hard to bet against Apple. And maybe in the future we are in our autonomous driving Apple car. Wearing our apple glasses, while we’re on our apple phone, buying products from the Apple app and they’re making money on every which way. And if that happens, they’ll keep doing quite well, but you never know. I never would have expected them to dominate the smartphone market the way they do today, if you look back ten years ago. Well, I know, in particular, you’re one of the last guys that knew who had a galaxy phone. So when I text you, I get this ugly green text message notification on my screen. So you held out for a while. I mean, Apple, I think, makes me feel a little bit more comfortable as well. The investment legend himself, Buffett, he’s a big shareholder in Apple. And I think that has propelled Berkshire’s returns. The other thing, and I agree with you on Netflix, it’s almost like how much streaming can you consume at some point people were just sick of their cable bill and they wanted to unbundle everything and they just wanted everything separate. And you get Netflix, it’s interesting, it’s unique. I used to get it back in the DVDs and the mail day. And then now all of a sudden, I’m tallying up all I’m paying for these different streaming services. I’m like, what the heck just give me my cable bill back and put all those channels on there. So you’d have to assume with all that competition, it would hurt them. I guess one other thing kind of connected to that, if you are going to invest in individual stocks, which we don’t, I probably don’t recommend it as a do-it-yourself investor. But you look at a company like Disney that’s sold off kind of maybe in sympathy with Netflix’s streaming concerns, Disney has a lot of things going for it besides just Disney+. So if you are looking at your portfolio, if you are looking at businesses, you do want to make sure that you’re not bailing out on a Disney, which is a much different value proposition just because you’re seeing some challenges in a network. Absolutely. Let’s just how diversification works, having a broader lines of business helps a company like Disney, or as Netflix is all in on streaming. And one thing with markets and economics it’s competitive. There’s a lot of people out there, a lot of companies trying to make money. And if your top of the hill and streaming, other companies are going to go after you and compete. And if you’re all in on something like streaming as Netflix, that can catch up to you over time. So what would you say now, let’s say, I mean, we talked to potential new investors all the time. And what if your next meeting was with somebody who had a concentrated position in these FAANG names and they said to you, you know, Bob, what do I do? I don’t want to sell now that they’ve sold off. But I also know I own too much of them. What would we be telling somebody like that? Yeah, I think now we actually have some good data and you can point to what happened in Netflix down 70%, what happened to Facebook down 50%. And that’s what happens with single stock risk. When you invest, you’re taking risk. When you take a risk, you want to get a return. So if you think about, say, invested in the S&P 500 Index fund, you’re taking what’s called market risk, and with market risk, you get market return. If you take 500 people, we all line up and we all take one company and the S&P 500 collectively we’re all taking more risk. Collectively we’re all going to get the same return. So that’s just the math of diversification. So that’s just the direction, making sure that they’re aware that they’re taking higher risk that on average, it’s not compensated risk.
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So it’s not risk you want to take. And that’s why you should cut the position to the extent you can pay some taxes. And get other assets in the portfolio. Yeah, and with them having outperformed for so long, I think I said from like 2016 through 2021 and then the struggles this year. I think a Netflix and a Facebook and I refuse to call it math. Sorry. Basically, now they’re trailing returns are not that impressive. They’re longer-term returns. They’ve given back a lot of that almost all of that outperformance if I’m if I remember correctly. Yeah, no, definitely. I mean, that’s how the math works. You have to do well for a while to sustain a 70% drawdown and still look good. So a lot of these companies and investments you see it where they’ll just be hot and run and run and run and you wonder, when is this thing going to come back down to earth? And when it does, it can be painful for investors and you can give up years of gains pretty quickly and that’s what some people have unfortunately seen on these stocks. Awesome Bob, this has been a great conversation. Interesting to me, always to talk to you about these and hopefully our listeners did as well. If I can ask you, what are you thinking about from an investment standpoint these days? What’s on your desk? I know you’re not sitting around thinking about the FAANG stocks day in and day out. But what is on your mind? What are you concerned about? What are you looking at with the markets? The big topic these days is inflation. We’ve seen the inflation print over 8% last month. That’s high, and Powell was so dovish last year. Talking about transitory inflation and that’s coming back to bite the Fed. And it’s just hoping that they can slow things down, get inflation back to a moderate pace. You hear the phrase soft landing. If that’s what we’re looking to see. So that plays into the bond market and seen the losses on the bond market this year with bonds down about 9% if you’re just looking at the general account, that’s really where focus is. What’s going on in bonds, what’s going on with inflation, fed policy, and that drives a lot of this. So we start talking about the exciting FAANG stocks and these big tech companies and maybe we’re ending with me talking about something that most people call pretty boring about interest rates, but also in the bond market. But I think that’s what’s most important these days. That drives stuff. Yeah, and the agg is the barclays capital agg, that’s a pretty commonly used index to track U.S. bonds. You talked about a soft landing as I think about that. What does that actually mean? If the fed is talking about raising rates 8 to ten times or whatever the market’s expecting, isn’t that already kind of off the table that you can have a soft landing if you’re raising rates that significantly? No, not necessarily. So basically, the economy is hot and inflation is high. The fed wants to slow things down. Have higher mortgage rates to slow down the housing market that people can relate to. And by increasing rates, you do that. The trick, the key is to not send us into a recession. So can you slow the economy down just the right pace? Hence the soft land. And so we still have economic growth, unemployment doesn’t take up too high. But we’re not seeing 8% inflation anymore. So that’s the balance that they need to do to get inflation down without signing a sensory session. Understood. Well, thanks a lot, Bob. I appreciate the conversation. And thank you all for listening today.
Thank you for listening to Wealthy Behavior. If you found the conversation useful, please consider leaving us a review wherever you listen to your podcast and sharing this episode so those around you can live a rich life too. For more insights, subscribe to our weekly blog and heritagefinancial.net and follow heritage financial on Facebook, Twitter, and LinkedIn. Check out my personal finance blog at thebostonadvisor.com. This educational podcast is brought to you by Heritage Financial Services, LLC located in the greater Boston area. The views and opinions expressed in this podcast are that of the speaker, are subject to change and do not constitute investment advice or a recommendation regarding any specific product or security. There is no guarantee that any investment or strategy discussed will be successful or will achieve any particular level of results. Investing involves risks including the potential loss of principle.
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About Wealthy Behavior: Heritage Financial Services
Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life. We’re Boston Massachusetts-based wealth managers who have been helping busy, successful people pursue their financial goals for more than 25 years. Hosted by Sammy Azzouz, President of Heritage Financial, Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life.