AMZN - Amazon.com Inc.

[muscleman]

Amazon's growing way faster than Geico was...

 

GEICO grows at 24% for 40 years. AMZN is in the early stages. If we look back 25 years later, will you be confident that AMZN grew at 24% for the past 40 years? Maybe. But in that case, I would buy at 8 PE, not 25 :)

 

Amazon was founded in 1994 and, iirc, it grew at hundreds of percents a year for the first few years. So the back end of the 40 years could have growth in the 15-20% range and the average CAGR could still be quite high.

 

Of course, you didn't buy it in 1994, so that's kind of moot :)

 

Well, that's not my point. My point is AMZN today compared to GEICO in 1967. GEICO was growing at 24% from 1967 to 1999. AMZN today grows at 29%, and may keep this rate for a while. Let's just assume for simplicity that AMZN will keep 29% per year for the next 20 years. How will a buy today at 25 PE for a 29% growth compare to a buy of 8 PE for a 24% growth in 1967? In the end, it doesn't matter which company or industry it is, after you adjusted the GAAP earnings to owner earnings.

[beerbaron]

Let's just assume for simplicity that AMZN will keep 29% per year for the next 20 years.

 

I hope your calculation was just to show the point of your argument because if Amazon were to grow 29%/Y for the next 20 years it would have sales of 12 Trillons Dollars. Bring this value to current dollars (2% inflation) and that gives 8 Trillions in current dollars... or about twice the size of the entire US retail market.

 

BeerBaron

 

 

[muscleman]

Let's just assume for simplicity that AMZN will keep 29% per year for the next 20 years.

 

I hope your calculation was just to show the point of your argument because if Amazon were to grow 29%/Y for the next 20 years it would have sales of 12 Trillons Dollars. Bring this value to current dollars (2% inflation) and that gives 8 Trillions in current dollars... or about twice the size of the entire US retail market.

 

BeerBaron

 

I think you misunderstood me. My point is that even with this 29% growth assumption, paying 25 PE seems too high for me. Not to say that this kind of growth seems unsustainable.

[blainehodder]

Let's just assume for simplicity that AMZN will keep 29% per year for the next 20 years.

 

I hope your calculation was just to show the point of your argument because if Amazon were to grow 29%/Y for the next 20 years it would have sales of 12 Trillons Dollars. Bring this value to current dollars (2% inflation) and that gives 8 Trillions in current dollars... or about twice the size of the entire US retail market.

 

BeerBaron

 

I think you misunderstood me. My point is that even with this 29% growth assumption, paying 25 PE seems too high for me. Not to say that this kind of growth seems unsustainable.

 

29% growth for 20 years is the foolish assumption... not the multiple if the 29% growth is a given.

 

If you had a perfect crystal ball and saw that 29% growth for 20 years was real, a 25 PE would be the bargain of a lifetime.  Assume the "E" in the PE were to grow at 29%/yr for 20 yrs.  The E would have multiplied by 162.9 times. Even if the multiple got cut in half to 12.5 at that point, you would have made an 81 bagger. Even if the PE mutiple went to 2 you would do very well. 

 

You could really pay 100 PE+ and do very well if the growth materialized.

 

Total Return (ignoring divs) = (Future Multiple/Current Mutiple)*(1+growth rate)^T

 

I suggest you read this post:

 

http://www.philosophicaleconomics.com/2014/03/wmt/

 

Your argument should be that assuming 20 yrs of 29% growth is wrong, not that the PE is too high if the 29% growth is realized.

 

 

[Palantir]

25x earnings is a blatant steal if a company grows 29% yoy in the future. Looks like you're anchored to what WEB paid for KO and GEICO, but to each his own...

 

Assuming a PE of 25, your Year 1 earnings are 4%, so your earning stream will look like

 

4, 5.16, 6.6, 8.6, 11, 14.3, 18.4, 23.8

 

Which is absolutely explosive.

 

 

[JAllen]

The below post is an amazing post and should be read by anyone really even thinking about AMZN as an investment.  Also, if you haven't read Sam Walton's autobiography, that is required reading as well, at least in the John Allen School of Business.  It's definitely one of the best business books.

 

http://www.philosophicaleconomics.com/2014/03/wmt/

 

"Now, what is the maximum price that you should be willing to pay for $WMT, knowing what it’s going to become?  And what sort of valuation would this price imply?  One way to answer the question would be to discount $WMT’s total return from 1974 to today at the rate of return of the overall market.  $WMT at $12 produced a 40 year annual total return of 23%.  It turns out that the price that would bring this return down to the market rate, 12%, is roughly $600.

In 1974, $600 for a $WMT share would have represented a PE ratio of more than 600.  In the current market, which is much richer, this would be the equivalent of something like 1500times trailing earnings–again for a company with undistorted earnings that has been in operation for decades."

 

Another great quote from that post:

 

"The next time we see an excellent business trading at 40 times earnings, or 75 times earnings, or 100 times earnings, or wherever, and we shy away, it might help to remember the example of Wal-Mart.  High multiples can be entirely justified, provided that the growth potential is real. "

 

Note that I don't believe AMZN is currently like what WMT was in 1974 - more like 1984 - with 15-20 years to grow rapidly.  The most important part is that it does have 5-10 to continue growing very quickly.  So I expect the next five years returns to be very high and the next still high, and then tapering off.  You would obviously still want to own AMZN now, or WMT in 1984.

Another thing to note is that WMT was twelve years old in 1974 - it was founded in 1962, and Sam Walton had been a retailer since the early 1940s.  So you can argue that buying AMZN now is like buying AMZN in 2006, when it was 12 years old, or you could argue that buying AMZN now is like buying WMT earlier than its official founding in 1962 because it was an agglomeration of stores Walton had been retailing for years prior.

Another thing to note here is that WMT was in one moderately capital-intensive business.  Amazon is in four and a growing number of lightly capital-intensive businesses.  This fact has large, positive ramifications for we long-term shareholders. In other words the total addressable market and ROIC are both incomparable to WMT.

[Laxputs]

If you had a perfect crystal ball and saw that 29% growth for 20 years was real, a 25 PE would be the bargain of a lifetime.  Assume the "E" in the PE were to grow at 29%/yr for 20 yrs.  The E would have multiplied by 162.9 times. Even if the multiple got cut in half to 12.5 at that point, you would have made an 81 bagger. Even if the PE mutiple went to 2 you would do very well. 

 

You could really pay 100 PE+ and do very well if the growth materialized.

 

(Future Multiple/Current Mutiple)*(1+R)^T

 

I suggest you read this post:

 

Can you solve for R and show me the equation: R = ....  (I'm unsure how to isolate R and want to be able to utilize this formula.)

 

And suppose a 35 multiple contracts to 15 over a 15 year time horizon. What is the return? Please show your work.

 

Great Wal-Mart post. Thanks for that.

[blainehodder]

If you had a perfect crystal ball and saw that 29% growth for 20 years was real, a 25 PE would be the bargain of a lifetime.  Assume the "E" in the PE were to grow at 29%/yr for 20 yrs.  The E would have multiplied by 162.9 times. Even if the multiple got cut in half to 12.5 at that point, you would have made an 81 bagger. Even if the PE mutiple went to 2 you would do very well. 

 

You could really pay 100 PE+ and do very well if the growth materialized.

 

(Future Multiple/Current Mutiple)*(1+G)^T = Total Return

 

I suggest you read this post:

 

Can you solve for R and show me the equation: R = ....  (I'm unsure how to isolate R and want to be able to utilize this formula.)

 

And suppose a 35 multiple contracts to 15 over a 15 year time horizon. What is the return? Please show your work.

 

Great Wal-Mart post. Thanks for that.

 

Oops, I was using the variable R= rate of growth... i guess i should have used the letter G for growth rate. Sorry (I've edited the post now). 

 

So, lets assume a 15% growth rate for fun snce you didn't state a growth rate for the earnings.

 

Your Example:

 

Future Multiple = 15

Current Multiple = 35

Growth Rate per year = 15% or 0.15 (for this example)

T = 15 years

 

so

 

Total Return (ignoring divs)= (Future Multiple/Current Mutiple)*(1+G)^T

 

where G = Growth rate and T = time in years.

 

 

(15/35) X (1 + 0.15)^15 years =  3.49 total return over the 15 year period.  a 3 and a half bagger.

 

This is total return % for the full 15 yrs not your CAGR.  To convert your total return to an annual return %, you would take Total Return^ (1/T). Note, I am ignoring divs.

 

so converting your 3.49 total return to CAGR -> 3.49^(1/15 years) =  1.087 or an 8.7% annual return.

 

You follow?  Perhaps start a different thread and we can continue there since this isn't AMZN analysis specifically.

 

 

[dwy000]

The math I find most troubling is just the basics:

 

If you want a 12% return on this stock for holding it for the next 10 years, the market cap in 10 years needs to grow to about $466bn (assume zero new shares are issued).

 

At 15x earnings that implies net income of $31bn.  At a 4% after-tax margin that implies sales of $776bn.

 

Will the company be able to grow revenues to $776bn over the next 10 years while simultaneously stopping growth spend in order to generate 6%+ pre-tax margins?

 

If you believe that to be true and want a 12% annual return then you should be buying.  If you struggle with any of the assumption or want a higher return for the risk then the stock is expensive today.

 

[rpadebet]

The math I find most troubling is just the basics:

 

If you want a 12% return on this stock for holding it for the next 10 years, the market cap in 10 years needs to grow to about $466bn (assume zero new shares are issued).

 

At 15x earnings that implies net income of $31bn.  At a 4% after-tax margin that implies sales of $776bn.

 

Will the company be able to grow revenues to $776bn over the next 10 years while simultaneously stopping growth spend in order to generate 6%+ pre-tax margins?

 

If you believe that to be true and want a 12% annual return then you should be buying.  If you struggle with any of the assumption or want a higher return for the risk then the stock is expensive today.

 

you make very valid points. Your guess here is as good as mine regarding the achievability of these targets.

 

But do you think $776bn ~5.5x current sales is unreasonable growth projection for e-commerce sales worldwide? WMT has 3/4 of those sales now and is able to sustain similar margins, why can't AMZN replicate that with a lighter model in 10 years? Also note AMZN has potentially higher "non-retail type" margin businesses in AWS etc which WMT doesn't.

[Fat Pitch]

"The next time we see an excellent business trading at 40 times earnings, or 75 times earnings, or 100 times earnings, or wherever, and we shy away, it might help to remember the example of Wal-Mart.  High multiples can be entirely justified, provided that the growth potential is real. "

 

At those multiples, the growth has to happen... not be "potential".

[dwy000]

The math I find most troubling is just the basics:

 

If you want a 12% return on this stock for holding it for the next 10 years, the market cap in 10 years needs to grow to about $466bn (assume zero new shares are issued).

 

At 15x earnings that implies net income of $31bn.  At a 4% after-tax margin that implies sales of $776bn.

 

Will the company be able to grow revenues to $776bn over the next 10 years while simultaneously stopping growth spend in order to generate 6%+ pre-tax margins?

 

If you believe that to be true and want a 12% annual return then you should be buying.  If you struggle with any of the assumption or want a higher return for the risk then the stock is expensive today.

 

you make very valid points. Your guess here is as good as mine regarding the achievability of these targets.

 

But do you think $776bn ~5.5x current sales is unreasonable growth projection for e-commerce sales worldwide? WMT has 3/4 of those sales now and is able to sustain similar margins, why can't AMZN replicate that with a lighter model in 10 years? Also note AMZN has potentially higher "non-retail type" margin businesses in AWS etc which WMT doesn't.

 

Never say never I guess!  But do I personally think AMZN will get to 5.5x current sales in the next 10 years?  No.  They'll be big.  Huge.  But not 5.5x current sales - that's averaging 19% per year for 10 years off of a massive base.  And especially if they need to stop spending on growth and start generating margins.  The logic of those 2 competing forces just aren't compatible in my mind.

[muscleman]

"The next time we see an excellent business trading at 40 times earnings, or 75 times earnings, or 100 times earnings, or wherever, and we shy away, it might help to remember the example of Wal-Mart.  High multiples can be entirely justified, provided that the growth potential is real. "

 

At those multiples, the growth has to happen... not be "potential".

 

Yes. The key to value investing success is how to be wrong and still not lose money, and if right, make a lot of money.

Paying aggressive multiples means if things go wrong, you are killed.

[Palantir]

^Buying AMZN is most certainly not "value investing".

[Fat Pitch]

"Value investing" is all about limiting your losses if you are wrong. It’s not about buying the most marginal business because it has a “low” multiple.

 

Amazon is a powerful model and I would like to own it. The current market “spread” for the business is not to my liking.

[spin]

Regarding growth rates, sustainability and probability this may be of interest:

 

http://www.lsvasset.com/pdf/Level-%26-Persistence-of-Growth-Rates.pdf

 

Spin

[peter1234]

^Buying AMZN is most certainly not "value investing".

 

Do you mean Amazon at any price or at the current price?

;)

[Palantir]

^At any price greater than about 10x PE or 1x BV or so. :)

[txlaw]

Google introducing $95 Prime competitor:

 

http://recode.net/2014/10/14/google-introduces-a-95-amazon-prime-competitor/

 

 

[JAllen]

Wrote a post about AMZN's share repurchases:

 

 

http://jallencapitalmanagement.com/posts/amzn-amazons-share-repurchases.html

[muscleman]

Wrote a post about AMZN's share repurchases:

 

 

http://jallencapitalmanagement.com/amzn-amazons-share-repurchases.html

 

Jeff Bezo clearly has a different valuation model than mine, and I do believe he is smart and understand AMZN better than I do.

The repurchase is definitely a sign that he thinks AMZN is cheap then.

The recent acquisition of Twitch with cash and loan is also such a sign.

 

Could anyone enlighten me about how Jeff's valuation model works?  ;D

[Eye4Valu]

"You bought what?

 

That brings me to our newest position, which will no doubt make some question our credentials as value investors: Amazon.

 

Consensus forward earnings for Amazon are a little over a dollar. At the median forward P/E multiple, Amazon would be priced in the low $20s. So, even though the stock fell $124 from its January high of $408 to a May low of $284, its P/E ratio remained in nosebleed territory. But we have never believed the P/E ratio was the be-all and end-all for valuation. Amazon is a retailer – a very efficient retailer. When we compare stocks in the same industry, we often compare their market caps to their sales rather than their earnings.  Since 2001, Amazon has generally traded at a cap-to-sales ratio of two to four times that of the average bricks-and-mortar retailer.  Having fallen to just under two recently, one might say that, as an advantaged retailer, Amazon looks somewhat attractive.

 

But that metric misses an important change in Amazon’s business.  Third-party sales (sales on amazon.com where the seller is not Amazon) have grown more rapidly than Amazon’s direct business.  And on those transactions, accounting rules credit only Amazon's commission as revenue.  So if you buy a $100 item on amazon.com from a third party, Amazon is only allowed to show about $13 of revenue, nearly all of which is gross profit.  For third-party sales, Amazon is effectively functioning as the mall owner, collecting a percentage of sales as rent.  Amazon earns less gross profit on that sale than an average retailer would, but it is also a much lower risk endeavor.  For that reason, we think a dollar of third-party sales should be worth about the same as a dollar that Amazon sells directly.

 

It gets interesting when we adjust our cap-to-sales ratio comparison to include estimated gross third-party sales.  Instead of selling at twice the ratio to sales of the average bricks–and-mortar retailer, Amazon is selling at only 80%.  So, relative to gross sales, Amazon's stock would have to increase 25% to be priced consistent with the very companies whose survival Amazon is threatening.  On that metric, Amazon has never been cheaper.

 

Should Amazon sell at a discount on sales? The answer largely rests on what Amazon could earn if it wasn’t investing so heavily for future growth.  For most asset heavy businesses, growth investment is primarily on the balance sheet, and is slowly expensed on the income statement as depreciation throughout its useful life.  In an asset–lite business like Amazon, however, most growth spending gets directly expensed to the income statement, creating a much larger immediate reduction in income.  We believe that if Amazon sharply curtailed its growth spending so that it only grew at the rate other retailers grow, it could produce similar operating margins.  But we don't want them to do that.  We believe that management is maximizing value by investing heavily for super-normal organic growth.  So, yes, Amazon is a rapidly growing business.  But at this price, we believe it is also a value stock."

 

William C. Nygren, CFA

Portfolio Manager

[dolce far niente]

I have nothing smart to add to this discussion.

http://blogs.hbr.org/2014/10/at-amazon-its-all-about-cash-flow/

 

 

 

According to my instructor in such matters, Harvard Business School finance professor Mihir Desai, the key metric of a company’s cash-generating prowess is the cash conversion cycle, which is days of inventory plus days sales outstanding (how long it takes your customers to pay you, basically), minus how many days it takes you to pay your suppliers. Super-efficient retailers such as Walmart and Costco have been able to bring their CCC down to the single digits. That’s impressive. But at Amazon last year, the CCC was negative 30.6 days.

 

The only remotely comparable company with a CCC in Amazon’s range is Apple, where last year’s cycle was an even longer -44.5 days. This is in itself an interesting phenomenon. In the past, Desai says, the companies that threw off huge amounts of cash were generally in low-tech industries with addicted or at least very faithful customers — tobacco, gaming, groceries. Now here are two cutting-edge companies operating in often-fickle markets, and they’re cash machines.

 

..

 

Actually, though, it isn’t inventory management that distinguishes Amazon from Walmart and Costco. Walmart has an “inventory velocity” similar to Amazon’s while Costco, with its limited selection, turns its inventory substantially faster. Walmart and Costco also both get paid by customers more quickly than Amazon does. Where Amazon stands out is how excruciatingly long it takes it to pay its suppliers — 95.8 days on average last year, according to Morningstar, compared with 30.1 for Costco and 38.5 for Walmart.

[KCLarkin]

Any idea why WMT doesn't request equivalent payment terms? It doesn't seem like AMZN has more leverage over their suppliers than WMT.

[muscleman]

"You bought what?

 

That brings me to our newest position, which will no doubt make some question our credentials as value investors: Amazon.

 

Consensus forward earnings for Amazon are a little over a dollar. At the median forward P/E multiple, Amazon would be priced in the low $20s. So, even though the stock fell $124 from its January high of $408 to a May low of $284, its P/E ratio remained in nosebleed territory. But we have never believed the P/E ratio was the be-all and end-all for valuation. Amazon is a retailer – a very efficient retailer. When we compare stocks in the same industry, we often compare their market caps to their sales rather than their earnings.  Since 2001, Amazon has generally traded at a cap-to-sales ratio of two to four times that of the average bricks-and-mortar retailer.  Having fallen to just under two recently, one might say that, as an advantaged retailer, Amazon looks somewhat attractive.

 

But that metric misses an important change in Amazon’s business.  Third-party sales (sales on amazon.com where the seller is not Amazon) have grown more rapidly than Amazon’s direct business.  And on those transactions, accounting rules credit only Amazon's commission as revenue.  So if you buy a $100 item on amazon.com from a third party, Amazon is only allowed to show about $13 of revenue, nearly all of which is gross profit.  For third-party sales, Amazon is effectively functioning as the mall owner, collecting a percentage of sales as rent.  Amazon earns less gross profit on that sale than an average retailer would, but it is also a much lower risk endeavor.  For that reason, we think a dollar of third-party sales should be worth about the same as a dollar that Amazon sells directly.

 

It gets interesting when we adjust our cap-to-sales ratio comparison to include estimated gross third-party sales.  Instead of selling at twice the ratio to sales of the average bricks–and-mortar retailer, Amazon is selling at only 80%.  So, relative to gross sales, Amazon's stock would have to increase 25% to be priced consistent with the very companies whose survival Amazon is threatening.  On that metric, Amazon has never been cheaper.

 

Should Amazon sell at a discount on sales? The answer largely rests on what Amazon could earn if it wasn’t investing so heavily for future growth.  For most asset heavy businesses, growth investment is primarily on the balance sheet, and is slowly expensed on the income statement as depreciation throughout its useful life.  In an asset–lite business like Amazon, however, most growth spending gets directly expensed to the income statement, creating a much larger immediate reduction in income.  We believe that if Amazon sharply curtailed its growth spending so that it only grew at the rate other retailers grow, it could produce similar operating margins.  But we don't want them to do that.  We believe that management is maximizing value by investing heavily for super-normal organic growth.  So, yes, Amazon is a rapidly growing business.  But at this price, we believe it is also a value stock."

 

William C. Nygren, CFA

Portfolio Manager

 

This guy could be wrong. I asked a few times in this board about this guy's calculation, which I am unable to replicate, and no one was able to tell me what's wrong with my calculation, which means this guy is more likely to be wrong.