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FAAMG is Highly Overvalued: Is it Worth Paying the Premium?

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FAAMG stocks are having a scintillating year despite the coronavirus-led disruption. The group has shown extreme resilience against the brutal pandemic-induced economic downturn. These companies also played a crucial part in curbing the spread of the infection.

FAAMGs through their tools and services have been instrumental in tiding over the “new normal” that witnessed work-from-home, online learning and telehealth wave as people were confined to their homes due to lockdowns and shelter-at-home guidelines. They have become household names due to pandemic-driven change in consumer behavior and lifestyle.

Markedly, FAAMG is a relatively new acronym coined by Goldman Sachs as a modification of FAANG, wherein Microsoft (MSFT - Free Report) replaced Netflix (NFLX - Free Report) owing to the streaming giant’s comparatively smaller market capitalization.

FAAMGs Are Highly Overvalued

Although the appetite for FAAMGs remains strong among investors, there are growing concerns that FAAMGs have become too pricey and the current earnings momentum might not be sustainable in 2021 despite continuing technological innovation.

Markedly, in terms of market capitalization, the FAAMGs account for more than 22% of the S&P 500 index. Moreover, in terms of index weight, Apple (AAPL - Free Report) , Microsoft, Amazon (AMZN - Free Report) , Facebook (FB - Free Report) and Alphabet (GOOGL - Free Report) are the top five constituents.

Apple is currently the best-performing stock among FAAMGs, trailed by Amazon. Both the stocks carry a Zacks Rank #3 (Hold).

Returns from Microsoft, Facebook and Alphabet have also outperformed the S&P 500, which is up 16.6% year to date. While both Facebook and Alphabet carry a Zacks Rank #3, Microsoft has a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Year-to-Date Performance

 

Moreover, FAAMG stocks are currently trading at a significant premium to the S&P 500. For instance, on the basis of the forward 12-month P/E, FAAMG stocks are currently trading at 33.09X compared with the S&P 500’s 22.94X. FAAMGs have traded as high as 36.65X, as low as 24.96X and at the median of 31.41X, as the chart below show.

Forward 12-Month P/E

 

In terms of forward 12-month P/S, FAAMG stocks are currently trading at 13.19X compared with the S&P 500’s 4.34X. FAAMGs have traded as high as 15.52X, as low as 9.46X and at the median of 11.85X, as the chart below show.

Forward 12-Month P/S

 

Moreover, increasing regulatory scrutiny and anti-trust issues have become a major headwind. The legislators are planning to break-up these big giants in order to democratize data flow and foster competition. These are expected to weigh on earnings growth prospects.

Growth Prospects Deserve a Premium

Nevertheless, FAAMG stocks deserve a premium due to several factors. Acceleration in cloud computing adoption is a major driver. The pandemic has accelerated digital transformation and cloud computing platforms are expected to play a key role.

Per Forrester Research data, cited by crn.com, the global public cloud infrastructure market will grow 35% to $120 billion in 2021. Moreover, Gartner estimates global end-user spending on public cloud services to grow 18.4% in 2021 to $304.9 billion compared with an estimated $257.5 billion in 2020.

Rapid adoption of cloud computing will surely boost demand for cloud infrastructure monitoring, web-based application performance management and human capital management solutions. This, in turn, enhances the prospects of cloud service providers in the FAAMG group. Moreover, proliferation of server-less computing and infusion of AI and machine learning into cloud services are other growth drivers.

Meanwhile, FAAMG stocks are well-poised to benefit from rapid adoption of 5G. Blazing fast speed is expected to boost media consumption as users will be able download movies in seconds. Moreover, proliferation of 5G is expected to boost the usage of AI, machine learning, deep leaning and IoT.

Further, a hybrid model that includes a couple of days of work from home is likely to be more popular among employees and has received support from the likes of Google CEO Sundar Pichai. The hybrid work model bodes well for the likes of Microsoft and Google as these companies offer a full-stack of video, chat, collaboration and office software.

Additionally, FAAMGs have shown keen interest in expanding into India and South East Asia, which presents far more growth opportunities compared with Europe and the United States.

FAAMGs Helping U.S. Tackle China

Undoubtedly, FAAMGs’ ability to innovate has helped the United States to tackle China in the technology space and gain a prominent position. Although plans regarding breaking up FAAMGs have been a hot topic of discussion among the lawmakers, the upcoming Biden administration is expected to take a measured approach in this regard.

Although regulation-related risk is expected to increase, any U.S. government approach that could stifle technological innovation for the FAAMGs would definitely provide a boost to China’s growing clout in the technology space. Since this would not be in favor of the United States’ national security, FAAMGs are expected to maintain dominance, at least in 2021.

Zacks Top 10 Stocks for 2021

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