Though taking a much needed breather today, Tesla is the latest and greatest market darling. The stock rose 400% from its 52-week low in June of last year through yesterday. Its market capitalization at yesterday’s close reached nearly $160 billion, and there are many who believe that figure will only increase from here. The stock’s meteoric rise over the past year has us thinking, once again, about the stock market’s dependence on just a handful of red-hot stocks. To eliminate the suspense (and confirm what you already suspected), the market’s dependence on the FAANGs and other high-fliers continues to increase.
Since we last broached this topic in our December 11, 2019 Market Commentary, the six FAANG stocks (we include Microsoft) have increased in value by over $700 billion in just 8 weeks! As of yesterday’s market close, the combined market value of the FAANG stocks was over $5.5 trillion, representing almost 19% of the total S&P 500 market capitalization and larger than the third-biggest economy in the world (Japan). The pie chart below shows that from the end of 2018 through yesterday (February 4), the six FAANG stocks were responsible for an enormous 29% of the S&P 500’s total return of 34.4% (including dividends). In other words, if you owned an index of the S&P 500 excluding the six FAANG stocks, you would have only made 24.4% instead of 34.4%. That’s a pretty astounding figure given that the FAANG stocks represent only 1% of the total stocks in the S&P 500.
We should mention at this point that Tesla is not yet included in the S&P 500. Still, we wanted to see how an equal-weighted index of the FAANG stocks, including Tesla, would have performed over the past few years. The chart below shows that the “FAANG+ Index” increased by about 170% (or 38% annualized) since the end of 2016 through yesterday compared to just 49% (or 14% annualized) for the S&P 500. A quick glance at the chart will also tell you that the FAANG+ outperformance has only accelerated in recent months. Investors have been piling into these stocks as if they are fearful of being forever left out of the club. The sharp spike in the orange line at the end of the series is due to the contribution from TSLA over the past few weeks.
We’re not trying to warn anyone against owning any of the FAANG stocks, or even TSLA for that matter. In fact, we own three of the FAANGs in our client portfolios (NOT Tesla!). But not all the FAANG stocks meet our investment criteria, which include an excellent track record, strong corporate governance, a fortress balance sheet, strong free cash flow, a defensible market position, no reliance on external funding, and yes, a REASONABLE valuation. The FAANGs that do possess these qualities could also prove somewhat defensive when we, inevitably, go through the next market downturn. But those whose stock prices are built more on momentum and hope could be in for a much rockier ride.
This is a long-winded way of saying that each individual stock should be evaluated on its own merits and with your particular goals in mind. We are simply trying to point out that the stock market’s returns would have been dramatically lower if not for the incredible performance of these seven FAANG+ stocks. And more importantly, you should know that when you decide to buy a mutual fund or exchange-traded fund (ETF) that aims to track the performance of an index, like the S&P 500, you will be getting outsized exposure to stocks, like the FAANG+ stocks, that have done fabulously well and, as a result, now represent very sizeable weightings in some of the major indices. If you are an investor who relies heavily on valuations, for instance, you may not want all the exposure to these high-flying stocks. The lesson, then, is that some research and due diligence is required even if you are buying passive investment vehicles that only seek to track the market!