The impending economic recovery may well mean the big tech stocks will cede their market leadership for the time being. But the FAMAG stocks remain attractive on a long-term basis, says Julian Cook, portfolio specialist for US equities at T. Rowe Price. Apart from one though.
‘I think about 70% of the Russell 1000 Growth Index move this year has been about valuation appreciation,’ says Cook. This is a one-off windfall, mainly caused by the fall in interest rates and unlikely to be repeated next year. At the same time, the FAMAGs have benefited from demand being pulled forward because of the pandemic as people have been adapting to the working-from-home environment. ‘So, more people have been replacing things like iPads and iMacs which had benefited Apple’s sales for example. Amazon has likewise seen demand being pulled forward.’
Lost momentum
So Cook would not be surprised to see the FAMAGs lose some momentum in 2021. And this in fact has already been happening. Amazon’s share price, for example, is now significantly below its September peak. The same goes for Microsoft, Apple and Facebook. Alphabet (Google) is the only FAMAG that has seen its share price rise since September.
The lacklustre FAMA(G) performance has got everything to do with the impending switch to value stocks. ‘Once the vaccine news came through, we saw this strong rebound of cheap cyclical stocks which could last into next year. It’s perfectly acceptable that this is happening,’ says Cook.
Google a value stock?
Perhaps this dynamic explains the relative recent outperformance of Google versus the other FAMAGs: Though the T. Rowe Price US Growth Fund has an allocation of 8.3% (?) to Alphabet, the company could be considered to be a value stock, according to Cook. ‘Even some of our value investors at T. Rowe Price are currently buying Alphabet because the company is trading at a discount compared to its component parts. Alphabet probably has the biggest artificial intelligence capability anywhere, but just the fact this is not being monetized right now doesn’t mean it has no value. The same can be said about Alphabet’s technology for autonomous driving which is also hugely valuable.’
Amazon
Cook believes, however, that the other FAMAGs also have the ability to weather the current change in macro environment. ‘Amazon may indeed see a moderation in growth once the lockdowns are lifted, but much of the growth they have seen during the pandemic will prove permanent.’ Cook also has high expectations of Amazon’s venture into the grocery business. ‘Amazon’s investment in [online] groceries in the US is many years ahead of the competition. It may be surprising to know that Amazon’s retail logistics footprint was already 1.3x the size of its main retail competitor WalMart in 2019 and is expected to grow by a further 50% this year. The company is significantly outspending Walmart in terms of distribution capabilities with an estimated incremental investment of $7-8 billion for one-day shipping on top of two decades of spending in logistics.. Groceries is very attractive because it’s a regular item. If you manage to deliver groceries in combination with other items that will be extremely good for your margins.’
Finally, Cook notes Amazon has found a new growth engine in its advertising business. ‘Amazon is increasingly acting like a supermarket which lets sellers pay for points of prominence. It’s the fastest growing online advertising business in the US, and stepping up its competition with Facebook and Google.’
Cook is also constructive about Facebook, claiming the company ‘probably looks cheaper now than one or even two years ago.’ Facebook received some bad publicity this year because it was perceived as to promote fake news and other divisive content on its platform. In response, several large companies withdrew advertising budgets from the social network. However, this has not seemed to affect Facebook’s revenues. ‘This advertising boycott was the biggest fake charade I’ve ever seen,’ comments Cook. ‘It wasn’t meaningful because these companies simply don’t have an alternative to Facebook to reach their desired audience. The return on invested capital from digital ads is simply so much higher than from TV or print advertising.’
Underweight Apple
The future also looks bright for Microsoft, according to Cook. ‘The increased demand for digitization by companies that has been the consequence of the pandemic comes in the form of recurring revenue streams. Companies are increasingly embracing the cloud for mission-critical applications too now, so they are engaging with the cloud at a greater degree now. That’s hugely beneficial for Microsoft.’
The only dissonant among the FAMAG’s is the world’s largest company, Apple. ‘Apple’s increase in revenues has been mostly a one-off with the upgrade cycle for new products in this new work-from-home environment having pulled forward demand,’ says Cook. ‘This should make it harder to grow from here, especially since we don’t see enough innovation in their products to convince us the replenishment cycle is going to accelerate.’
Concentration risk
Despite their negative view on Apple, it’s still the fifth-largest position in the T. Rowe Price US Growth Equity Fund. Isn’t that a little strange? ‘Well, Apple has a 11% weighting in the Russell 1000 Growth benchmark, and we have a guideline that individual position sizes are typically not over- or underweight the benchmark by more than 500 bps. We are currently outside that range for Apple and would look to return to within range over a 12-month period. In practice, this would mean the fund has to up its allocation to Apple at a moment it has a negative view on the company’s share price, an awkward dilemma indeed…
The rule also cements an inherent concentration risk. After all, the Russell 1000 Growth Index is heavily tilted towards the FAMAGs. ‘It’s true that without getting the FAMAGs right, it’s going to be more difficult to outperform. If you miss Tesla or Apple, it can drag your performance significantly’, Cook admits.
However, he also notes the T. Rowe Price Funds SICAV - US Large-Cap Growth Equity Fund has generated positive alpha over the benchmark over the last 17 years and managed to outperform this year , even without owning Tesla and being strongly underweight Apple. ‘You have to make up for this with other ideas.’ And these profitable bets are often found in relatively less well known disruptive companies . ‘To give you an example, in March this year we took a position in Carvana, an online platform for selling second-hand car sales. This is a huge $800bn market with very low online penetration. We bought the stock between $25-40, and now it’s over $250 . ‘In fact, this stock contributed more alpha to our clients than Amazon this year.’