Want to buy an investment that's yielding considerably less than a 10-year Treasury but with much, much more risk? Apparently everyone does.
Shares of the the so-called FANG block of technology companies have rocketed up this year, rising nearly 40 percent, four times the gain of the S&P 500. And the trend doesn't seem to be ending. The technology heavy Nasdaq Composite Index raced ahead of the broader S&P 500 again this week. On Wednesday, Bank of America released a survey of fund managers who said Nasdaq stocks were now the most overcrowded trade.
And yet as investors pile into the FANG stocks, one measure of the return investors can expect from those stocks has shrunk to a new low. As of the end of the second quarter, the average free cash-flow yield of the FANG stocks, based on the past 12 months, slid to just 1.4 percent. That's less than half of what that measure was just two years ago and now nearly a full percentage point below the yield on a 10-year Treasury.
Some of the stocks in the group aren't generating any cash at all. Earlier this week, Netflix reported that it blew through nearly $600 million in the second quarter. The streaming video service is expected to use up just more than $2.1 billion this year, more than double the amount of cash it burned just two years ago. Free cash flow is considered a better measure of the true cash a company generates because, unlike Ebitda or other measures, it factors in the capital expenditures a company makes to keep its business growing. And it is more encompassing than just the dividend yield, capturing all the cash that a company generates and not just what it pays out.
The cash-flow concerns, especially relative to the companies' soaring valuations, are reminiscent of the 1990s dot-com tech market. What eventually popped that bubble was the so-called burn rate, the fact that many companies were torching money faster than they could raise it. The situation is better now. As a group, the market's hottest tech stocks, which include Facebook Inc., Amazon.com Inc., Apple Inc., Netflix Inc., Nvidia Corp., Google's parent Alphabet Inc., as well as Tesla Inc., generated a hefty amount of cash, an estimated nearly $100 billion in the past year alone. Only two are burning cash, Netflix and Tesla.
But for many of those stocks, the amount of cash they are generating is meager relative to their elevated prices, signaling a problem ahead.
To calculate the average free cash-flow yield, I compared the last 12 months of cash flow to the current market cap of the seven stocks and then averaged them. That average was dragged down by the negative cash-flow yields of Netflix and Tesla. Taken as a group, rather than individually and averaged, the free cash-flow yield of the FANG stocks is 3.7 percent, which, while better than Treasuries, is still the lowest it has been in nearly five years. But that average is buoyed by Apple, which generates more than half of the group's cash flow and the most of any S&P 500 stock. Remove Apple, and the group is starting to look stretched.
At the start of the year, besides Tesla and Netflix, which are not generating cash, every other FANG stock had a free cash-flow yield that was higher than the interest rate on 10-year Treasuries. Now Nvidia, the maker of graphics chips used by computer gamers, and Amazon yield just 2 percent and 1.7 percent respectively. Facebook's yield is not much higher than the 10-year Treasury.
Of course, investors are buying the FANG stocks for the growth and not their current yields. And if Telsa and Netflix and the other stocks end up generating a lot more positive cash, investors will be rewarded eventually. Until they do, though, it hard to see how the market's hottest stocks can keep rising.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.