Why FAAMG stocks Q3 earnings this week matter more than ever

This week is big tech earnings galore with all the FAAMG reporting Q3 results – that’s Facebook, Apple, Amazon, Microsoft and Google-parent Alphabet & it’s more important than ever.

Must know

• These five companies that make up the FAAMG grouping of companies are now worth 22% of the S&P 500, which means they are dominating index price action.
• With the addition of Netflix, these stocks make up almost all of the outperformance of US stock markets in the last five years.
• FAAMG stocks are so heavily overvalued – that they are more richly valued than Nifty Fifty stocks in the Indian stock market bubble of the 1970s.
• The high valuations have put off fund managers who are predicting – unsuccessfully so far – a rotation into ‘value’ stocks.
• EARNING PREVIEW: We go through the numbers expected for EPS and revenue this week

FAAMG Matters

The following chart really shows all you need to know about the difference these giant technology stocks are making to Wall Street. Without the inclusion of these six stocks, US stock markets would only just be outperforming global stock markets. In reality, when these mega cap tech stocks are included, the S&P 500 handily outperforms the MSCI World index. Taken in isolation, the growth in these six stocks is in the stratosphere versus the rest of the stock market.

(Source: Gerard Minack)

The charts above show this outperformance in price- but also show the price gains are in concert with forecasted earnings. This is where it becomes necessary to analyse whether each of these companies deserve such high earnings expectations based on past performance.

Valuations

While earnings forecasts are rising, price is still elevated on a historical basis- even when compared to what we now know through hindsight were some of the biggest bubbles in stock market history. The chart below shows the forward P/E of the FAAMG stocks today contrasted with the demand for Indian stocks in the Nifty Fifty in the late 70s. At that time India had gained independence from Britain and investors piled into the country’s stock market in expectation of huge growth, only to eventually be disappointed with huge deflation in asset prices- which have never returned to such levels again.

(Source: Michael A. Gayed, CFA @leadlagreport)

A point of hilarity for outsiders but one of huge frustration to insiders of the ‘buy side industry’ of hedge funds and pension funds is that so-called 'Robinhooders' or retail traders have been outperforming them this year. Mutual funds tend to invest on a valuations basis – and the valuations in the FAAMG stocks – as we have just demonstrated – have been off the charts and rising for the past five years. Now mutual funds have a relative exposure to FAAMG stocks at the lowest in five years- meaning these stocks now represent the smallest percentage of these funds’ portfolios as the stock prices hugely outperform what is in the rest of these portfolios.

(Source: Goldman Sachs)

FAAMG Earnings Preview

Let’s go letter by letter and run though what these giant companies are doing and what analysts are expecting for results this week.

F = Facebook

Performance: The stock is up 36% in 2020 and even more from the lows made in March.

Story: Under social distancing rules, people have had to rely on social media for communicating more than ever. Although total advertising spend is lower in 2020 amid the recession – the pandemic has seen businesses spend proportionally more of their ad spend online and on Facebook. Facebook seems best placed to be the next company to reach a $1 trillion valuation.

Earnings: Facebook reports earnings on Wednesday (Oct. 28) after the close. For Q3, analysts expect revenues will have risen to $19.73 billion with an EPS at $1.89.

A = Apple

Performance: The stock is up 55% this year and 85% over the past year.

Story: The new product launches in September and the October launch of the new iPhone 12 – Apple’s first 5G iPhone won’t affect the third quarter results but will play a big part in the forward guidance. The biggest growth driver for Apple now is its services and accessories businesses. 

Earnings: Apple reports earnings on Thursday (Oct. 29) after the close. For Q3, revenues are expected at $64.16 billion with an EPS of 71 cents.

A= Amazon (AMZN)

Performance: Amazon stock is up 74% year-to-date and 82% in the past year.

Story: The megatrend of online shopping has accelerated with stay-home orders and social distancing rules- this has increased both revenues and costs as Amazon adjusted to new supply chains and the extra demand. Relating to Amazon's profitability, out-of-office demand for cloud computing is expected to have bolstered its AWS business.

Earnings: Amazon reports results on Wednesday (Oct. 28). Analysts expect revenues of $92.5 billion and an EPS of $7.27.

M = Microsoft (MSFT)

Performance: Microsoft stock is up by 34% this year and 50% over the last 12-months.

Story: The work-from-home environment has bolstered sales of its Windows operating system with PC demand bucking its multi-year trend of lower sales. Its Azure cloud business remains a top growth-driver as business attempt to work more flexibly. The new Xbox is released in November so that will be a story for Q4.

Earnings: Microsoft reports earnings on Tuesday (Oct. 27). Revenues are expected at $35.7 billion while EPS is forecast at $1.55.

G= Google [Alphabet] (GOOG)

Performance: Alphabet stock is up 19% in 2020 and 26% over the past year.

Story: Last week Google was sued by the US department of Justice in the biggest antitrust case since Microsoft in the 1990s. The suit has been long-expected and has likely been a drag on the stock. Otherwise online advertising trends continue to favour Google and its dominance in online search remains unchallenged.

Earnings: Google reports results on Thursday (Oct. 29). Sales are expected at 42.77 billion and EPS at $11.18 in Q3.

Summary

If you’re looking to trade during earnings season, make sure to check out our guide Why a stock go up after earnings and how to trade it

Thanks for reading and happy investing!