It is no secret that stocks rise in bull markets. However, anyone tracking indexes achieves market returns. The true alpha comes from investing in market out-performers. It just so happens that the acronym for market leaders in this bull market is FANG (Facebook, Amazon, Netflix, Google).
The best traders advise being long strong stocks and being short weak
stocks. Furthermore, this strategy sees the most dramatic returns when traders focus on the best performing names in bull markets. Conversely, the strategy shows the highest returns being short weak stocks in bear markets.
This bull market is the longest in history, thus some names must show incredible outperformance. The theory states that if one has an opinion on market direction, he trades only FANG names. Conversely, if he feels confused on market direction, simply look to FANG names. The market needs them in order to move higher.
FANG In The Market
Next, let’s examine this theory in practice. Last year, returns were 53%, 56%, 55%, and 33% for FB, AMZN, NFLX, and GOOG respectively. Compared to the S&P500’s return of 21% . FANG names showed extreme alpha, or the amount of returns over the market. Sure enough, these stocks moved higher before the market as a whole did, showing they are a true leading indicator. Lagging indicators such as stochastics are typically noisy, however, market leading stocks are black and white. Price allows for no discrepancies.
Furthermore, this strategy gives a good sentiment indicator for risk appetite among investors. Note that these are all names in the technology sector. The companies identify as “growth” companies, meaning investors are willing to pay high multiples in the hopes that these names continue growing into their valuation. When investors buy high dollar stocks with large market caps, but Wall Street considers them undervalued, it shows that the markets risk appetite is present.
Using this information, other trade ideas abound. For example, if a trader believes that risk-on sentiment is present, she may buy FANG stocks and sell safe havens such as gold. Understanding the market leaders gives savvy investors an edge over their counter parties.
Breaking Down FANG
Next, we will detail individual names and inspect why these companies are so attractive.
Facebook (NASDAQ : FB) provides various products to connect and share through mobile devices, personal computers, and other surfaces worldwide. This company grew earnings-per-share (EPS) over 230% the past 5 years. For a growth company, this is paramount. Interestingly, this company has a price-t0-earnings (P/E) ratio of 27. This is not extreme compared to the overall market.
Furthermore, recent negative press pressed the price lower. Interestingly enough, the entire market sold off. FB soon recovered off its lows, followed by the market. The market leading phenomenon is strong and important.
Amazon (NASDAQ : AMZN) engages in the retail sale of consumer products and subscriptions in North America and internationally. This company’s rapid growth granted it recent entry into new space, such as entertainment. Growth companies constantly look for new market share and revenue streams. With a P/E ratio of over 320, the company needs to continue to innovate and grow. It certainly has, showing EPS growth over the past 5 years over 120%.
Netflix (NASDAQ : NFLX) an Internet television network, engages in the Internet delivery of television (TV) shows and movies. This company is the first of its kind in the industry, and solidified its place as one of the most successful in history. Despite its high valuation of P/E over 230, it continues to grow subscribers every quarter at an alarming rate.
Alphabet Inc. (NASDAQ : GOOG) provides online advertising services in the United States and internationally. Despite being an industry giant for two decades, the company continues making strategic acquisitions. Through this practice, the company grey sales quarter-over-quarter (QOQ) ~24%. Once again, we see a relatively modest P/E of 59. Investors note when market leading stocks have a large dispersion in valuation among the top performers.
Finally, FANG names are leading this market higher. As simple as that sounds, understanding the fundamentals and driving factors behind these names gives investors enough information to outperform the market consistently. Take special note of changes in these names relative to changes in the market. They may even signal the end of a market cycle.