Overvaluation Bites — Avoid FANG Stocks!

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FANG stocks were all the rage last year, and without their stellar performance the indices would have fared far worse than the final numbers for the year.

Overvaluation Bites — Avoid FANG Stocks!

The four stocks averaged more than a 60% gain last year, as momentum investors just kept buying. The valuations, however, are in the nosebleed levels — the average price-earnings ratio surpasses 250 with an average of nearly nine times sales.

When I expressed doubts about the current FANG valuations, one wag told me with a whiff of new-age superiority that this was why one used discounted cash flow analysis to the FANG stocks to find their true worth.

I am not a big fan of DCF for non-control investors, but let’s take a look and see if my new age stock valuation find is correct and FANG is actually cheap using DCF.

I will use each company’s weighted cost of capital as a discount rate and see what we find.

FANG Stocks to Sell: Facebook (FB)

FANG Stocks to Sell: Facebook (FB)Facebook (FB) is one of the greatest time wasters in the world, although I do find it mildly useful for promoting my business and staying in touch with old friends. Every spouse on the planet shudders when they hear, “Hey, honey, come look at this cute video I found on Facebook.”

At any rate, Facebook has a weighted average cost of capital of 9.28%, so let’s see what we find using a DCF calculator. Analysts think the company can grow by 30% a year for the next five years, so I will extend it and use it for the 10-year rate. Ding! Then I get $74.45 a share.

Reverse engineering that we find that Facebook needs to grow by 35% for the next 10 years to justify the current price. I don’t think there are that many cat videos in the world.

FANG Stocks to Sell: Amazon (AMZN)

FANG Stocks to Sell: Amazon (AMZN)Amazon (AMZN) is a great company and investors have done well holding it, but it has not ever been cheap.

At some point the market will want to value the stock based on sales and earnings, and that’s when I think the story will prove to be very expensive.

Amazon has a weighted average cost of capital of 13% so lets plug that into the DCF model and see what we get. Analysts expect the company to grow by 60% for the next five years, so we will use that for the 10-year growth rate.

I come up with $229 a share even using that aggressive growth rate. If I double the terminal growth rate to 10%, which is very aggressive, I get $270.

If I reverse engineer the current value the 10-year cash flow growth rate would have to be 74% to justify the current valuation level. Amazon is a great company, but that’s a huge hurdle.

FANG Stocks to Sell: Netflix (NFLX)

FANG Stocks to Sell: Netflix (NFLX)Netflix (NFLX) is a good company, but the model is attracting competition. We have Netflix, but of late, I find we are watching as much, if not more, Amazon Prime.

Netflix has an weighed average cost of capital of 12%, so we will use that to value the companies.

As with the other two stocks I will use the five-year estimated growth rate of 24.5% for the 10-year rate of cash flow growth. Using those inputs I find that the stock is currently worth about $16.60.

To justify the current price the company needs to grow by 54% a year for the next decade. I could be wrong but I just do not see that happening.

FANG Stocks to Sell: Alphabet (GOOG, GOOGL)

FANG Stocks to Sell: Alphabet (GOOG, GOOGL)Google is now Alphabet (GOOGGOOGL), but FANA does not sound anywhere near as cool as FANG, so for this exercise it is still Google. Again, Google is a great company, but we may be paying too much for a good business.

They have a cost of capital of 9% and a five-year growth rate expectation of 14.70, so those are the numbers we will use. Using these inputs I come with a fair value of $584 for this company.

To justify the current price the company has to grow by 18.48%, well above expectations. Alphabet is less overvalued than its fellow FANG stocks, but that doesn’t make it cheap.

As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/01/fang-stocks-fb-googl-amazon-netflix/.

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