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Martin Tillier

Martin Tillier

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Why You Should Buy FANG, Not FANG

Whatever you think of CNBC pundit Jim Cramer, and opinions do vary, he has shown a knack in the past for coming up with phrases and acronyms that pass into the vernacular. The most recent, and probably most widely adopted of those was his lumping together of four big tech stocks, Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOG: GOOGL) and referring to them as the FANG stocks. At the moment, as the result of a combination of scandals, privacy issues and opposition to their market dominance, all are facing possible regulatory headwinds. Combine that with an average P/E for the four of around 80 and investors may be better off looking at another FANG.

Diamondback Energy (FANG) are a Midland, Texas based oil and gas exploration and production (E&P) company with a focus on the Permian Basin. That geographical limitation has proven to be a positive over the last few years as the costs of producing from unconventional wells in the region and getting product to market have fallen, enabling them to remain profitable throughout some quite serious volatility in commodity prices.

Despite that though, the stock has spent all this year stuck in a range of around $95-115. It is near the top of that range now and positioning for a breakout looks like a reasonable play.

A large part of the reason is contained in one basic metric. FANG has a forward P/E of just under 10 which, while far better than the S&P 500 average, is not that unusual for an E&P company. What it also has, however, are growth estimates from analysts for the next five years that average over thirty-five percent per year. That gives a P/E to Growth (PEG) ratio of 0.39. Anything below 1.0 is deemed to represent value, so clearly that word describes FANG at this point.

Implied value like that obviously gets noticed, and that is part of the reason that now would be a good time to look for a break from the range. This morning, for example, FANG was included in Bank of America Merrill Lynch’s list of best small and mid-cap ideas for the second half of 2019. Nor is BAML alone in their assessment. Twenty-eight of the thirty Wall Street firms that cover the stock rate it either a buy or a strong buy, with the other two both having a hold rating.

Readers who are familiar with my style may be aware that usually that kind of unanimity scares me. It means that downgrades that would drag the stock down are far more likely than upgrades that would give it a boost, but that is only really a danger if the price reflects the prevailing sentiment. In this case, as you can see from the chart, it does not.

What the chart does show though, is a good setup for a breakout trade. The low from nine days ago just below $104 provides a level off which to set a stop, while if $115 is breached there is plenty of room to run to the upside. The fact that a relatively tight stop makes sense here doesn’t mean however that this has to be a short-term trade. Diamondback has solid growth prospects for years to come, so the idea would be to use the momentum generated by a breakout to give a cushion, then set a trailing stop.

There are risks of course. Most obviously, oil could drop again and or natural gas prices could go even lower dragging the stock down. That, however, is an ever-present concern in energy investing and is why setting and sticking to stop loss orders is always advisable. But, even if commodity prices just stabilize at these levels, the fundamental value and growth potential in the stock will at some point get reflected in the price. That makes this FANG more attractive right now than Cramer’s acronym.

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