The FANMAG Phenomenon
In my earlier posts, I argued that the market effects of this crisis have been disparate, with capital-intensive, debt-laden and rigid firms being worse affected than firms that are capital-light and flexible. You see this play out in the returns you see across sectors, industries and regions. In fact, with returns updated through August 14, 2020, technology companies are now showing healthy gains from where they were at the start of this crisis, up 11.82% since February 14, 2020. There is an inside story to this success, and it revolves around six companies – the original FANG stocks and Apple and Microsoft. They have been responsible not just for the bulk of the returns among technology companies, but have also provided the thrust for the overall market’s recovery.
FANGAM – Tale of the Tape
To understand the FANGAM story, let’s retrace our steps to when there were only four young companies in this group, Facebook, Inc. (NASDAQ: FB), Amazon, Netflix and Google Alphabet Inc (NASDAQ: GOOGL) (FANG) and look at how two of their senior counterparts, Apple Inc. (NASDAQ: AAPL) and Microsoft Corporation (NASDAQ: MSFT), entered this group. In the table below, I list out the founding date for each of these companies, together with the date of their public offerings, the market capitalization at the time of the offering and the years in which each company hit market cap milestones ($100 billion, $500 billion and $1 trillion):
Looking at the six companies, they vary in age, with Microsoft being the oldest and Facebook the youngest, but they have also had extraordinary revenue growth in the last two decades, albeit from different bases. Coming into 2020, Apple, Amazon and Microsoft had already hit trillion-dollar market caps, and they were joined by Alphabet in 2020, and Apple crossed the $2 trillion threshold just two days prior to this post. I find the construct of a corporate life cycle useful in explaining the evolution of companies over time, in both corporate finance and valuations.
For most companies, aging is accompanied by three phenomena. The first is that revenue growth decreases as companies scale up, with the speed of deceleration in growth a function of competition in the business. The second is that profit margins, which are negative or very low when companies are young, improve as companies grow, with the magnitude of improvement depending upon the economies of scale in the business, but plateau as new competitors emerge. The third is that even the very best companies reach mature growth, where they remain profitable, but struggle to grow and create value at the same time. The FANGAM stocks stand out from the rest of the market, since they have, at least so far, found the antidote to aging, continuing to grow even as they get larger, while sustaining or even improving profit margins. Breaking down how each of these companies deviate from the norm, here is what I conclude:
– Amazon, the Original: In an era, where every company claims to be the “next Amazon”, it is worth remembering that the original company’s rise to global dominance came with hiccups and interruptions. After its stint as the poster child for the dot com boom, Amazon’s online retail business flirted with failure in 2001, but survived and prospered in the next decade. By the end of the decade, though, it seemed like Amazon’s story had run its course, but just as investors were readying for the company becoming a mature retailer, the company reinvented itself as a disruption platform, ready to go after any business it chose to, with an army (Amazon Prime) backing it up.
– Apple and Microsoft Corporation (NASDAQ: MSFT), the Reincarnation Duo: By tech company standards, Apple and Microsoft are old companies that should be struggling to hold on to their customers and fighting off competition. Both companies though seem to have found a way to move the clock back, and retain their status as growth companies. Apple, given up for dead in the late 1990s, found its answer in streamed music, smartphones and tablets in the following decade. Office and Windows were the cash cows that kept Microsoft going for much of its corporate life, but after seeing growth flatline in the software business, the company found new growth in a subscription model (Office 365) and the cloud business.
– Alphabet and Facebook, Inc. (NASDAQ: FB), the Advertising Juggernauts: Google and Facebook have had almost uninterrupted growth, since their founding, as they have not only taken advantage of the shift to online advertising, but also dominated that shift, while also delivering profit margins in the stratosphere. Along the way, they have accumulated huge user bases, giving them the power to influence not only where people shop, but also what they think, and perhaps even how they vote.
– Netflix Inc (NASDAQ: NFLX), the Shape Shifter: Of the six stocks, the one that has had to make the most mid-course corrections, changing its business model to reflect a changing world, is Netflix. It started life as a video rental service, mailing DVDs to its customers, and undercutting Blockbuster, the dominant player in the business then. It pivoted quickly to become the leading streaming player, renting its content from movie and TV producers, and offering them to subscribers. As content producers squeezed the company, it shifted its business model again to make its own shows and movies, becoming the largest spender on content in the business. Along the way, it has gone global, and its business machine not only has a huge base of subscribers, but finds ways to keep adding to that base.
