As market volatility reached new highs this week, CNBC began talking about something called “FANG Investing.” Most commentators showed great displeasure in the fact that prior to the recent downturn high growth companies such as Facebook Inc (NASDAQ:FB), Amazon.com, Inc. (NASDAQ:AMZN), Netflix, Inc. (NASDAQ:NFLX) and Google Inc (NASDAQ:GOOGL) (FANG) had performed much better than all the major market indices. And, in the short burst of recent recovery these companies again seemed to be doing much better.
Coined by “CNBC Mad Money” host Jim Cramer, he felt that FANG investing was bad for investors. He said he preferred seeing a much larger group of companies would go up in value, thus representing a much more stable marketplace.
Sound like Wall Street gobblygook? Good. Because as an individual investor why should you care about a stable market? What you should care about is your individual investments going up in value. And if yours go up and all others go down what difference does it make?
Most financial advisers today actually confuse investors much more than help them. And nowhere is this more true than when discussing risk. All financial advisers (brokers in the old days) ask how much risk you want as an investor. If you’re smart you say “none.” Why would you want any risk? You want to make money.
Only this is the wrong answer, because most investors don’t understand the question – because the financial adviser’s definition of risk is nothing like yours.
To a broker investment risk is this bizarre term called “beta,” created by economists. They defined risk as the degree to which a stock does not move with the market index. If the S&P down 5%, and the stock goes down 5%, then they see no difference between the stock and the “market” so they say it has no risk. If the S&P goes up 3% and the stock goes up 3%, again, no risk.
But if a stock trades based on its own investor expectation, and does not track the market index, then it is considered “high beta” and your broker will say it is “high risk.” So let’s look at Apple the last 5 years. If you had put all your money into Apple 5 years ago you would be up over 200% – over 4x. Had you bought the S&P 500 Index you would be up 80%. Clearly, investing in Apple would have been better. But your adviser would say that is “high risk.” Why? Because Apple did not move with the S&P. It did much better. It is therefore considered high beta, and high risk.
You buy that?
Thus, brokers keep advising investors buy funds of various kinds. Because the investors says she wants low risk, they try to make sure her returns mirror the indices. But it begs the question, why don’t you just buy an electronic traded fund (ETF) that mirrors the S&P or Dow, and quit paying those fund fees and broker fees? If their approach is designed to have you do no better than the average, why not stop the fees and invest in those things which will exactly give you the average?
Anyway, what individual investors want is high returns. And that has nothing to do with market indices or how a stock moves compares to an index. It has to do with growth.
Growth is a wonderful thing. When a company grows it can write off big mistakes and nobody cares. It can overpay employees, give them free massages and lunches, and nobody cares. It can trade some of its stock for a tiny company, implying that company is worth a vast amount, in order to obtain new products it can push to its customers, and nobody cares. Growth hides a multitude of sins, and provides investors with the opportunity for higher valuations.
On the other hand, nobody ever cost cut a company into prosperity. Layoffs, killing products, shutting down businesses and selling assets does not create revenue growth. It causes the company to shrink, and the valuation to decline.
That’s why it is lower risk to invest in FANG stocks than those so-called low-risk portfolios. Companies like Facebook, Amazon, Netflix, Google — and Apple, EMC, Ultimate Software, Tesla and Qualcomm just to name a few others — are growing. They are firmly tied to technologies and products that are meeting emerging needs, and they know their customers. They are doing things that increase long-term value.
McDonald’s was a big winner for investors in the 1960s and 1970s as fast food exploded with the baby boomer generation. But as the market shifted McDonald’s sold off its investments in trend-linked brands Boston Market and Chipotle. Now its revenue has stalled, and its value is in decline as it shuts stores and lays off employees.
Thirty years ago GE tied its plans to trends in medical technology, financial services and media, and it grew tremendously making fortunes for its investors. In the last decade it has made massive layoffs, shut down businesses and sold off its appliance, financial services and media businesses. It is now smaller, and its valuation is smaller.
Caterpillar tied itself to the massive infrastructure growth in Asia and India, and it grew. But as that growth slowed it did not move into new businesses, so its revenues stalled. Now its value is declining as it lays off employees and shuts down business units.
Risk is tied to the business and its future expectations. Not how a stock moves compared to an index. That’s why investing in high growth companies tied to trends is actually lower risk than buying a basket of stocks — even when that basket is an index like DIA or SPY. Why should you own the low-or no-growth dogs when you don’t have to? How is it lower risk to invest in a struggling McDonald’s, GE or Caterpillar or some basket that contains them than investing in companies demonstrating tremendous revenue growth?
Good fishermen go where the fish are. Literally. Anybody can cast out a line and hope. But good fisherman know where the fish are, and that’s where they invest their bait. As an investor, don’t try to fish the ocean (the index.) Be smart, and put your money where the fish are. Invest in companies that leverage trends, and you’ll lower your risk of investment failure while opening the door to superior returns.
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