There’s no denying that, in the nine years since the end of the worldwide financial crisis, growth stocks and funds have been on an upward tear, to a large extent at the expense of those classified as value. But everyone living in the reality-based world knows that markets tend to be cyclical and that everything — both good and bad — has to end at some point. The question no one has been able to answer is when that moment will come.
To start with, let’s look at one of the major forces driving the market’s upward momentum. A large portion of the underperformance of value funds in recent years can be explained by the outperformance of the FANG (Facebook, Amazon, Netflix and Google) group and other index-boosting, “FANG-like” stocks. Most of these high-flyers have some combination of: a good story, high sales growth rates, minimal profits under generally accepted accounting principles (GAAP), triple-digit GAAP price-to-earnings ratios, highly levered balance sheets, and levitating stock prices.
Technology has changed everything, but perhaps investors are bit overconfident in terms of the long-term growth prospects and concurrent returns offered by some of these new business concepts. To illustrate the point it may be helpful to take a closer look at a couple of examples of “new economy vs. old economy” companies.
Let’s start by looking at retailing. Amazon has certainly revolutionized the shopping experience for American consumers, but while brick-and-mortar stores have faced massive challenges, they’re not going away anytime soon.
In March, Amazon became the second-most valuable company in the world when its market cap hit $768 billion. Yet between its founding in 1994 and the end of 2016, its cumulative GAAP profits were only $5.1 billion.
By comparison, Walmart’s cumulative GAAP profits during the same time period were $223 billion, or more than 43 times higher. Yet Amazon’s market cap was twice that of Walmart’s. Fast forward to today, and Amazon’s market cap ($778 billion) is now about 3 times Walmart’s ($245 billion), and in the past 12 months, Amazon’s stock price is up 70% compared with an 8.5% rise for Walmart. Amazon’s trailing P/E is 253x, Walmart’s trailing P/E is 26x.
Here’s another salient example from the entertainment field: Netflix (NFLX) vs. Disney (DIS). This table shows the GAAP profits for each company since Netflix’s initial public offering in 2002.
In 16 years, Netflix has earned cumulative GAAP net income of about $2 billion, while Disney earned $78 billion. (Netflix has never produced positive cash flow). And yet as of today, both companies have similar market caps (NFLX $142 billion and DIS $150 billion), with Netflix at 268x trailing earnings, and Disney at only 16.7x. In the past two years, Netflix’s stock price is up over 250%, while Disney’s is up 1%.