Goldman Is Missing The Point On FAAMG

by: Intelligent Speculator

Goldman issues a report comparing the top tech names to the dominant players before the 2000 tech crash focusing mostly on profitability.

Context is critical and FAAMG (FB-AMZN-AAPL-MSFT-GOOG) is a group of players with tremendous power that qualify as ecosystems.

They have rightfully not focused on profits as a group but rather on building businesses that in many ways are monopolies and will give them tremendous staying and pricing power.

We live in a new economy which I've written about several times: one where a few tech names dominate headlines and their markets. They are usually known as "FANG" (Facebook (FB)-Apple (AAPL)-Netflix (NFLX)-Google (GOOG)), Goldman actually named them FAAMG (taking out Netflix but adding Amazon (AMZN) and Microsoft (MSFT)), which is an accurate way of looking at it, in my opinion. Those are the 5 ecosystem players I've written about in recent years. The logic for Goldman not including Netflix was its small weight in the S&P 500. I've personally excluded it because while I am a big believer in NFLX's business, I do not count it as an ecosystem. Netflix does not have different types of businesses that end up offering products and services through Netflix and through which NFLX could earn a "tax". Netflix is one of the few companies that has been able to leverage these new ecosystems rather than get crushed by them.

Goldman's report compared those 5 names to the biggest companies prior to the 2000 technology bubble burst - one of the biggest market crashes in recent history. The results were enough to shock the market. Just look at the returns since then:

That's still a small setback when you look at a broader 5 year picture:

What did Goldman look at exactly? It looked at the bigger names at the time:


What Goldman found was that, while the 2017 names have better cash flows, cash balances, and valuations, they lacked in terms of profitability and total assets. To some extent, that might be surprising when you consider Apple being part of the 2017 group, but remember that AMZN offsets it with a nearly 0% profit margin.

Goldman's Analysis Is Incomplete

I strongly believe that Goldman should have pushed that analysis much further. Why? Because FAAMG is built on quasi-monopolies. If you look at back at that 2000 list, the only name that could have been argued to have such a monopoly was Microsoft which, by no coincidence, is also the only name to make both lists. FAAMG is comprised of mega tech players that are extremely dominant and unlikely to be disrupted for some time:

Facebook: Social web
Apple: iOS/high end mobile ecosystem
Amazon: Cloud computing and ecommerce
Microsoft: O/S, Cloud
Google: Search, Youtube

Why are they so unlikely to be disrupted? Mainly 3 reasons:

  1. Network effects: Building a new social network is not impossible, of course, but Facebook has shown over and over that the challenge is significant because it can simply use its 2 billion user network to crush any potential competitor (copying of Snapchat features is one core example). Other examples would include Apple (App Store, iMessage) and Google (Youtube).

2. Data: In an era of big data, AI and machine learning are starting to have a big impact on these companies. For example, Google's search engine has much more data to work with to improve itself, making it incredibly challenging for others to compete. As we move to machine learning and AI, data will become incredibly valuable making it very difficult for incumbents to challenge the big players. Think about tasks such as self-driving cars, medical research, etc.

3. Physical and Digital Barriers: When Amazon built its Prime Business, it created an incredible program that gives its customers a strong incentive to only shop at Amazon. While doing that, Amazon has put enormous resources into automated warehouses and drone deliveries, making it increasingly difficult for competitors to be able to compete. Amazon has been willing to be incredibly aggressive in cutting prices to eliminate competitors. That has led these players to take a lead on platforms such as the app store for phones, tablets, tv's, video viewing, payments, storage, personal assistants, and advertising.

With Amazon moving into groceries and drone deliveries, Facebook moving into VR, Apple into self-driving cars, Google into everything from ISP to self-driving, medical research and AI, it's clear that we're just getting started.

Some will argue that those players are becoming too big and need to be stopped or slowed down by anti-monopolistic legislation. The case is much more difficult to make for digital companies where competition is usually one click away and many products are offered for free.

That makes a world of difference. These companies are very likely to remain dominant for the next 10-20 years. If the question isn't about if the world is moving to digital/clouds but about who will end up winning, I'd argue that the odds these 5 names will remain at the top makes them incredibly valuable. While Amazon remains incredibly difficult to value, in my opinion, others such as Facebook, Apple, and Microsoft are much more straightforward and by their current valuations I'd argue, remain very attractive.

They Have Not Focused As Much On Profits

One clear flaw looking back the 2000 dot com bubble was the lack of profitability (or even plan to become so) for many of the top names. I'd argue that Apple is the one player out of the 5 that has focused on profit margins, but for the others the money has been incredibly well spent. Amazon is the best example, in my opinion, as I've argued that AMZN should continue to reinvest any money it can into the business for the next 5-10 years. It continues to increase its dominance on competitors and while there is a short term cost, it will be able to profit greatly in the long term future.

Facebook has also been sticking to its long term plan to build a significant user base, establishing a need for businesses, and eventually focusing on monetization. Only "core Facebook" has reached that step with Instragram also starting to get traction in terms of revenues, but other messaging products (Messenger and Whatsapp) are not bringing any type of contribution to revenues or profits at this point. Google and Microsoft have both been able to generate solid growth in their core business (search and Windows+Office) but have been growing their cloud businesses, artificial intelligence capabilities and others in the background.

Goldman is right that FAAMG has lagged the top 5 names from 2000 in terms of profitability, but I'd argue that the comparisons should stop there. The 5 players have dominant products and are heavily focused on building on those ecosystems to prevent competitors from seriously threatening them. They are thus far in better positions than the 2000 big players, and I'd argue that the current decline creates a great buying opportunity.

Disclosure: I am/we are long GOOG, FB, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.