They’re Baaaack . . .

The U.S. stock market has been on a roller coaster ride in 2018 and has recently moved back into positive territory. The much-celebrated FANG stocks have told the story of the broader market so far in 2018. Following a blistering start to the year which saw the average FANG stock (we include Facebook, Amazon, Alphabet, Netflix and Apple) surge 26%, the group fell 13% on average from March 9th to April 2nd. However, since that April 2nd low, the average FANG stock is up 23% with all five stocks trading at or very near their all-time highs. The chart below tracks the cumulative price change (not including dividends) for the S&P 500, the average FANG stock, and the average FANG stock weighted by beginning market capitalization. It’s easy to see that these five stocks have been heavily influential to the market at large.

Source: Bloomberg“FANG” stocks include Facebook, Amazon, Alphabet, Netflix and Apple.  Market-Cap weighted average uses market capitalizations as of year-end 2017

We thought we’d take a look at the year-to-date change in market capitalization for the five FANG stocks and compare that to the S&P 500 to determine just how important the FANG stocks have been to overall market returns thus far in 2018. The table below shows that the five FANG stocks have grown in market capitalization by $544 billion to $3.3 trillion so far this year. The increase in the S&P 500 (which consists of 500 stocks!!) has been just $641 billion. Therefore, five FANG stocks representing just 1% of the total companies in the S&P 500 have been responsible for 85% of the total increase in S&P 500 market capitalization.

 Sources: Bloomberg and Factset
Though investors like to lump the FANG stocks together and they have a tendency to trade together, not all FANG stocks are alike; these companies are actually quite different from one another.  Facebook and Google are both highly profitable, high-growth tech stocks that trade at PE ratios that appear reasonable (e.g. 25x earnings) in light of their well-above average long-term growth rates and a market multiple of 18x earnings.  Amazon and Netflix are both rapidly growing companies that are not particularly profitable (at least not yet) and trade at PE ratios in the 125x-135x range.  The latter FANG stocks do not fit Farr, Miller & Washington’s investment discipline because the valuations are too high.
The narrow market leadership this year has left many solid companies trading at reasonable valuations.  Farr Miller attempts to take advantage of this narrow leadership by buying conservative, blue-chip stocks that many investors have neglected as they chase stocks that have already gone up a lot in the past few years.  Stocks trading at sky-high PE ratios can continue to rise for a long time.  However, expensive stocks are risky and could have a long ways to fall when growth rates eventually begin to slow.  Ten years into the current bull market with the Fed raising interest rates, we don’t believe that now is the time to take excessive risk.  Please continue to enjoy the current market environment but now, more than ever, is a time to know exactly what you own and how much you are paying for what you own. Narrow market leadership can provide a unique opportunity to consolidate long-term positions that can reap long-term rewards.