First Trust: Don’t write off the Internet just yet

Even if you’d wanted to, you just can’t escape from the FANG stocks over the last year. The Facebook, Amazon, Netflix and Google quartet achieved a combined market cap exceeding US$2 trillion1 and account for over 6% of the US market’s entire value2. Recent gyrations in their share prices continue to make headlines.

With these businesses soaring on the back of technology advancement and big data, investors tend to view their growth as just a tech-sector story. However, in investment terms, half the FANGs don’t qualify as tech at all; Amazon and Netflix are consumer stocks. Similarly, tech-driven businesses such as Veeva have been seeing record growth in Q2 20183 (with net income increasing by 192% Y-O-Y), but is classified as health care.

Investors therefore face an ongoing conundrum: now that almost every company uses technology to drive its business today, how do you invest in tech?

Thematic investing can help. The Internet, though inherently tech-based, sprawls into practically every corner of the economy. By basing your investments on the internet theme you’re investing not just in the strengths of a specific company, but also in the way technologies are transforming the behaviour of consumers and the world we live in today.

Designed with this purpose in mind, the Dow Jones Internet Composite Index SM (The “Index”) measures the performance of the 40 largest and most actively traded stocks of US companies that generate at least 50% of their cashflows from internet-related business. As a result, it has captured better growth than both the S&P500 and the tech-geared S&P 1500 Technology over the last decade.

Source: Morningstar, 31 May 2018. Earnings Growth – The average of the available third‐party analysts’ estimates for three‐ to five‐year earnings per share (EPS) growth. Equity Style Factor Historical Earnings Growth – A measure of how the stock’s EPS has grown over the last five years. Equity Style Factor Book Value Growth – A measure of how the stock’s book value per share (BVPS) has grown over the last five years. Equity Style Factor Sales Growth – A measure of how the stock’s sales per share (SPS) has grown over the last five years. Equity Style Factor Cash Flow Growth – A measure of how the stock’s cash flow per share (CFPS) has grown over the last three to five years.

Strong Fundamentals:
Just as generating alpha is becoming tougher than ever, these strong fundamentals have resulted in positive excess returns of the index over the last decade.

Notably the FANG stocks have still been growing their earnings and user bases. For Amazon, not only is the company still accelerating both its revenue growth and gross margins – driven mostly by its retail business – but its cloud business still accounts for just 10% of its revenue4 and is growing faster than Amazon as a whole.

Despite Facebooks’ recent tumultuous share price drop, looking at trailing P/E measures, the stock is now historically cheap. Second quarter 2018 results underwhelmed analyst’s estimates, with an all-time low P/E of 27.265. Despite some of the concerns which sent the stock down almost 20% in one day6, and the recent company news that they expect lower growth in the second half of 2018, some of the growth figures reported were in fact quite impressive. For example, Revenues (of which mobile ad revenues make up about 91% of the company’s total revenue) and Net Income rose by 42% and 31% Y-O-Y respectively.7

While the recent performance of these two companies is a perfect reminder of the importance of diversification, there is little to suggest that the power of internet to disrupt existing business models is running out of steam.

Source: Morningstar, 31 May 2018.

First Trust – A Thematic Past & Present
In response to this opportunity, First Trust has launched a UCITS ETF tracking the Dow Jones Internet Composite Index SM. Managing over 126 billion dollars in assets in June 2018, First Trust is the 6th largest ETF sponsor in the US.8

First Trust has many years’ experience in thematic investing solutions and today is one of the large players in thematic ETFs. Since the firm’s launch, First Trust has successfully launched a series of thematic products, which have including cyber security, blockchain and the internet. The US domiciled First Trust Dow Jones Internet Index ETF Fund has performed very well and proved popular with U.S. investors, growing from 4.4 billion to 8.3 billion in AUM in the last year alone as at 31 May 20189.

Source: Bloomberg, 31 May 2018. Past performance is not a reliable indicator of future results.

The Internet Evolution Continues
Legendary portfolio manager Peter Lynch famously advised “Invest in What You Know.” In this spirit, consider how often you use Google search, watch a YouTube video, and check your Gmail.

Or think about how often we turn directly to Amazon to look up or order a product. Also, bear in mind that three of the top four most popular social networks – where we spend a growing portion of our days (as per the adjacent chart)10 – are owned by Facebook.

The Internet Index captures the underlying themes that have the potential to shape tomorrow’s purchasing decisions, including the Subscription Economy theme (with holdings such as Dropbox and Spotify), and the Cloud Computing theme (with holdings such as Akamai Technologies and Juniper Networks).

By adding the Internet Index UCITS ETF – which is heavily allocated towards rapidly-growing firms – investors can also potentially gain heightened exposure to the much larger universe of up and coming challengers.

Some fund managers and fund selectors are only just beginning to tap into the value that thematic investing can add to an active portfolio. Join our upcoming webinar, presented by First Trust senior product specialist Gregg Guerin, and listen to further insights on the potential opportunities of the Internet growth.

Please click here to register for our webinar: http://ftgportfolio-events.profundcom.net/e/124/brighttalk-webinar

Sources:

  1. https://www.thestreet.com/story/14459254/1/fang-stocks-racking-in-2-trillion-in-collective-market-size.html
  2. https://www.barrons.com/articles/the-u-s-stock-market-is-now-worth-30-trillion-1516285704
  3. https://ir.veeva.com/investors/news-and-events/latest-news/press-release-details/2017/Veeva-Announces-Fiscal-2018-Second-Quarter-Results/default.aspx
  4. https://www.investors.com/news/technology/fang-stocks-q1-earnings-winners/
  5. Factset
  6. ttps://www.independent.co.uk/news/business/news/facebook-share-price-stock-market-value-crash-bad-results-mark-zuckerberg-a8464831.html
  7. http://citywire.co.uk/money/zuckerberg-under-pressure-as-facebook-plunges-20/a1141979?re=56788&ea=1113643&utm_source=BulkEmail_Money_Daily_Summary&utm_medium=BulkEmail_Money_Daily_Summary&utm_campaign=BulkEmail_Money_Daily_Summary
  8. First Trust Bloomberg
  9. https://www.ftportfolios.com/Retail/Etf/EtfPriceHistory.aspx?Ticker=FDN
  10. https://www.kleinerperkins.com/perspectives/internet-trends-report-2018
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Definitions:
Earnings Growth – The average of the available third‐party analysts’ estimates for three‐ to five‐year earnings per share (EPS) growth.
Equity Style Factor Historical Earnings Growth – A measure of how the stock’s EPS has grown over the last five years.
Equity Style Factor Book Value Growth – A measure of how the stock’s book value per share (BVPS) has grown over the last five years.
Equity Style Factor Sales Growth – A measure of how the stock’s sales per share (SPS) has grown over the last five years.
Equity Style Factor Cash Flow Growth – A measure of how the stock’s cash flow per share (CFPS) has grown over the last three to five years.
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