There was a time when investors and stock pickers thought there was no end in sight for the FAANGS (Facebook/Meta, Apple, Amazon, Netflix, and Google). As they say, “everything that goes up, must come down…”
There is always a risk when an investor is narrowly concentrated in individual stocks as opposed to a broad market asset class investment strategy.
A few headlines from this week regarding FAANGS:
In August 2022, Wes Crill of Dimensional Fund Advisors wrote an excellent piece on FAANG stocks.
FAANGs Gone Value
By Wes Crill, PhD – Dimensional Fund Advisors
One of the more vocal arguments against value investing stems from a belief that we’re in a “new normal” environment where innovative or high-tech companies have a leg up on “old guard” industries, such as energy or financials.
FAANG stocks have typically been the poster children for this position; these behemoth technology companies have contributed meaningfully to the market’s overall return and, by virtue of being growth stocks, the negative value premiums in recent years. Well, guess who showed up as value this summer!
That’s right, Russell reclassified Meta (formerly Facebook, the “F” in FAANG) and Netflix (the “N”) from growth to value during the index provider’s annual reconstitution event. Although signs have been pointing to the waning dominance of FAANG stocks since the start of 2022, it is somewhat ironic that 40% of the pillars supporting an aversion to value investing have now become value stocks themselves.
This also serves to highlight a possible misconception about the spirit of value investing. A value premium is a discount-rate effect: If expected future cash flows are not identically discounted for all stocks, then the ones with low prices relative to their expected future cash flows have higher expected returns. Investors advocating for the superiority of growth firms, such as the FAANGs, are inadvertently making the case for their expected future cash flows to be discounted at a lower level—all else equal, greater certainty around future success should be associated with a lower expected return.
In fact, as Exhibit 1 shows, this is generally what we see for stocks of companies once they grow to become among the largest in the market. In other words, investors should be careful about equating expected company success with expected stock returns.