There are some great opportunities in big tech.
FAANG stocks ruled the market for a decade.
The group that includes Meta Platforms (formerly Facebook), Amazon (AMZN 1.88%), Apple, Netflix, and Alphabet (GOOGL 3.78%) (GOOG 3.85%) (formerly Google) delivered monster returns for years, but most of these stocks have crumbled over the last year. Four of the five are down by more than 40% from their peaks last year.
Rising interest rates, recession fears, and other macro headwinds have pressured these stocks, bringing the most popular bet on Wall Street to an end.
However, in the fallout, there's opportunity, and two FAANG stocks look primed to reward investors over the coming years.
FAANG stock No. 1 to buy: $Amazon.com(AMZN)$
Amazon stock is down nearly 50% from its high a year ago, and its third-quarter earnings report shows why the mighty e-commerce giant has fallen.
The company stunned investors by guiding for revenue growth of just 2% to 8% in the fourth quarter, forecasting its slowest top-line increase ever in the holiday period. The stock fell 7% on that news and has continued to slide since then.
However, it's a mistake to think that Amazon's growth is permanently stalled. Like many of its peers, the company cited macro headwinds for the weakness, but performance is likely to improve in 2023.
First, the company's most profitable businesses -- like Amazon Web Services (AWS), its cloud infrastructure business, and advertising -- continue to grow at brisk rates. AWS revenue jumped 27% in Q3 to $20.5 billion, with an operating margin of 26%. In other words, AWS revenue run rate has reached $80 billion with operating income above $20 billion.
Advertising revenue, meanwhile, jumped 25% to $9.5 billion, or approaching a run rate of $40 billion. Amazon doesn't break out profits in advertising, but it's fair to assume that margins are likely in the 30% range, as they are at Google and Facebook.
The core e-commerce business has weighed on overall results this year as it's dealt with excess inventory levels, a capacity overexpansion during the pandemic, and e-commerce sales slowing generally this year as the global economy reopened.
In order to improve e-commerce profitability, the company is scaling back on warehouses and has imposed hiring freezes in a number of divisions. Last year, its e-commerce business, inclusive of advertising, brought in $6.3 billion in operating income. There's no reason Amazon can't get back there, especially with even higher revenue. If the e-commerce business turns positive again, the stock should get a significant jolt.
FAANG stock No. 2 to buy: $Alphabet(GOOG)$
Like Amazon, Alphabet stock is down sharply over the last year, and also fell on its recent earnings report. The Google parent reported just 6% revenue growth in its Q3 as macroeconomic headwinds weighed on the ad business, and the company continued to lose billions in Google Cloud and other bets. Ad revenue even declined for YouTube and Google Network, the ads it runs on partner websites.
Alphabet is also facing difficult comparisons with 2021, when brands were spending aggressively on digital advertising. In Q3 a year ago, its revenue rose 41%.
Management is responding to the slowdown in demand, and the company plans to dial down hiring into next year. After its headcount grew 25% over the last year, that should rein in costs and restore the company's usual profitability.
Alphabet stock has lost nearly 43% from its high a year ago, even though nothing fundamental has changed significantly in the business. The company still has a monopoly in search with market share of at least 90% in most of the world, and search advertising remains a high-margin growth market. In search, the company posted an operating margin of 50% in the quarter, and that was actually down from the previous year.
Alphabet doesn't have a license to print money, but the search business comes pretty close, and the only thing slowing it down is macroeconomic headwinds. Advertiser demand will eventually return, and when it does, the business and the stock are likely to rebound.
The FAANG stock trades at a price-to-earnings ratio of just 17, making it cheaper than the S&P 500. For a tech monopoly that still has a significant growth opportunity in front of it, that looks like a mistake.
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