EDIT: TLDR - Buy AMZN get Tendies - See comments for Trash Talk - Thanks for the Silver!
EDIT 2: Thank you u/Dmillehe spending his money on Platinum instead of AMZN stock. You're the real autist.
Amazon is going to dominate the next decade. It's a wonderful business trading at a discount to it's true ability to create cash earnings. My thesis is that traditional methods of valuation that work for most companies don't work for Amazon. This misunderstanding between market 'conservatives' or 'traditionalists' .. so called value oriented investors (of which I consider myself a part) is currently reflected in the share price today, and it's a mistake. Second, the firm has reached a point of inflection, where scale will now provide growth of earnings far in excess of growth in sales. This multiyear catalyst provides a fundamental basis for significant share price appreciation.
To understand why Amazon presents such a compelling investment opportunity, one must understand what is currently transpiring in two specific and unique business segments. E-commerce and Cloud Computing. Many of you are probably familiar with at least the former. The latter is foreign territory to most.
E-Commerce: Why Amazon is prepared to conquer the next decade in retail.
Traditional retail or brick and mortar (B&M from here on out) is still the dominant form of consumer spending in the U.S. and will be for some time. As of Q3 2019, total retail spend amounts to $5.4 Trillion dollar for the prior 12 months. E-commerce amounts to merely 11.2% of this amount (on a run rate basis.) While the size remains relatively small, e-commerce is growing in the mid-teens year over year, or now 5% quarter to quarter and the rate of growth is accelerating. The rate of E-commerce growth has doubled in 12 months.
To understand why this is the case, a qualitative evaluation of the differences between the two is critical. B&M requires physical space that is expensive to build and maintain. It requires uniformed, reliable, friendly and knowledgeable staff. It requires the deliberate presentation of inventory and restocking, amounting to a unique challenge to the retailer of determining layout of shelf space, product mix and promotion.
It's costly for the consumer too. They have to drive there, walk in, and find what they are looking for. This requires owning a car or putting up with public transportation. This can take a significant amount of time. There are some hidden costs too, without E-commerce, price discovery is a pain in the ass. Something retailers are keenly aware of. Here's something interesting about humans and economics. In economics, for a long time, we've modeled humans like they're these perfect rational beings. Ideally.. they'll drive down the road to a different store to get 3% off of whatever they're buying. Ideally. And you will do that for a car. But in reality, if it's 3% off a bag of chips, it's not worth the hassle. It's too expensive to go get $.14 of savings when you have to drive another 10 minutes to another grocery, walk in to figure it out if you're actually saving the most money.. consumers don't do that.
Consumers don't engage in price discovery on most of their small dollar purchases, they don't do that with traditional retail, because it's too costly in time and effort. There's too much friction in the trade-off.
The value proposition of E-commerce is that it saves consumers time and money. Getting in the car, loading the kids in the back, driving, parking, and then hunting for what you want, making sure you are getting a fair price, E-commerce throws all of that out the window. The value proposition for retailers too, is that it saves them time and money. There are plenty of retailers currently taking an omni-channel approach to retail, those who want to shop in person get to, those who shop online can do that too.. everybody wins. E-commerce takes the friction out of price discovery on small dollar purchases.
Given the advent of mobile computing more than a decade ago, many big box retailers also adopted a price match strategy, if you can find it online for the same price? Best Buy, Micro Center etc. they'll match it to keep you as a customer. But that's the extent of it, try going to Kroger and arguing with the cashier about Albersons having a 3/$5 deal on Frito Lay Potato Chips.. that ain't happening.
Amazon isn't Ecommerce, they are a part of it. Their strategy is different than the whole. They are technically omni-channel. However the little B&M they've done mostly as R&D experiment, more on Whole Foods in a minute. The Amazon E-Commerce thesis is this: At the end of the day, most consumer purchases are commodity purchases. They are small dollar items that are easily replicated. This segment of retail has yet to be disrupted by E-Commerce until now. It overlaps with specialty retail and big box items almost seamlessly from a logistical standpoint. The revenue streams are more stable than specialty retail, and it presents a massive opportunity in the long run.
I had the chance to speak with a finance manager at Frito-Lay (subsidiary of PepsiCo) years back after Amazon bought Whole Foods. Amazon had been attempting for years to get the same products you see in any Kroger or Albertsons onto their platform. For a variety of reasons, PepsiCo would not play ball with Amazon. It amounted to channel conflicts between the big established players vs. the disruptive incumbent. What Pepsico had done to Amazon, had been done by Proctor and Gamble, Nestle, Kellogg, and many more.
The purchase of Whole Foods was a big F U, a "we'll do it live" moment.. a Leeroy Jenkins. So you won't let us into your club? Fine, we'll do it ourselves. Grocer's panicked and for good reason. They were the reason Amazon had been held at bay for so long. They'd used their absolute size for many years to prevent E-commerce retailers from getting the same product mix at the same price online. Amazon responded by entering their territory, in buying a physical grocery chain. Grocer's fear was real and warranted, however the truly brilliant component of this purchase was that Amazon purchased for themselves a supply chain for grocery and private label products (365 brand.) Fast forward a couple years and Amazon now has over four hundred private label brands, more than twenty three thousand individual SKUs and 1.4 Million reviews of these products/brands. That entire article is worth a thorough read. Each product line represents a moonshot where amazon can collect both sides of margin on a private label product that disrupts traditional brands. Often it goes well, sometimes it does not, but the platform allows them to poke holes in each product category, and cannibalize the producer surplus of other more expensive branded product in the process. They don't have to advertise, market or promote any of this either.. yet it's already getting plenty of attention.
Here is a compelling example of how Amazon can undercut a premium brand with it's store brand knock off. And there's nothing Allbirds can do about it.
Amazon has built out an infrastructure of warehouses (which are relatively cheaper to maintain on a $/sf basis than traditional B&M retail space) and delivery drivers to meet the daily needs of consumers accustomed to B&M retail. They've disinter-mediated the entire process. You do not need a car, you don't have to be nice to the person behind the counter, or go hunting for that specific product you need on aisle 9, or check to see if the price is competitive or on deal. You can just type it in to your phone in 5 seconds, and see quickly who has the best deal. Turns out (and this is from experience) 9/10 times Amazon has the best deal and they'll ship it that day or the next.
For the consumer, it amounts to savings in both time and money. What the data shows is that we are experiencing rapid change in slow motion. E-commerce is growing explosively here in the U.S. however it's still of relatively small scale, that it will take some time before eclipsing B&M retail. Second, the data shows this rate of growth is accelerating, and has doubled in the last year or so. Traditional retail is not going to disappear entirely either. There are plenty of Amazon proof businesses for now. Hair salons, vets, dentists, nail salons, along with restaurants and apparel to a certain extent.
This online E-commerce platform has allowed Amazon to build out a peripheral advertising business in search. The search component allows Amazon to promote it's own store brand product alongside the branded counterparts. Second, it's able to sell web page space to branded products. Google currently dominates the search game, but Amazon is in 2nd place and stealing market share.
Finally, Amazon has rolled out a wonderful product called Subscribe and Save. Within this platform, Amazon is able to offer 15%-20% savings on everyday commodity items in exchange for a commitment to purchase at a monthly frequency (and it can be cancelled at any time.) What Amazon has discovered is that subscription purchases are relatively sticky. In exchange for a soft commitment from consumers that is relatively stable and predictable, Amazon can actually lower the cost of goods to the consumer. In turn, they are also able to optimize logistically for these sales as they can plan far in advance for them. Second, this allows them to relay demand information to other merchants as well. Example: Amazon can remit data to Tide, and let them know how many pods they expect to need in the coming months based on subscription commitments. Both Tide and Amazon are able to lower CoGS because they have more time to plan for those costs.
Furthermore, if you have an Amazon Credit Card through Chase bank, you get an additional 3%-5% all purchase at Amazon & Whole Foods.
The combination of all of these benefits as a platform amounts is an incredibly compelling value proposition to consumers. As of June this year Amazon has accumulated 105 Million Prime Memberships in the United States, and it is the largest paid subscriber base of any company in the United States period.
One of the luxuries I enjoy in my occupation is that my employer has a very long investment time horizon & high risk tolerance. What this allows is for us to kick back, put our feet on the table and think about what the world will look like in 10 years and how we'd consider being a part of it.
So here's a thought experiment, what do you think the retail experience for consumers looks like in a decade? Here's my prediction. Consumer's buy the vast majority of the things they need online, and they receive it within a few hours to a day, and they're spending less than ever before on what they need. This is already happening, and It's grabbed the attention of people like Jim Cramer, as well as Fed Chairman Jerome Powell. Albeit, E-Commerce is relatively small for now, but the rapid transformation is already causing ripple effects across retail. In 10 years, my thesis is that E-commerce becomes the largest component of total retail sales and Amazon remains the largest component of that segment, as it is today. Additionally, they probably steal share and grow at a faster pace than E-commerce as a whole, as they have done over the last several years.
Personal anecdote:
I'm sitting here in my home office wearing Amazon branded Jeans. I've got 10+ Amazon branded undershirts upstairs, along with 5+ pairs of Amazon Synthetic Golf Shorts. In my house, we've got Amazon branded batteries, note cards & printer paper, detergent pods, echo devices, cameras and more all over the place. There's more too, but I'm not going to list it all. In my experience, what they make is just as good if not better than the branded counterpart, and they do it for less, often a lot less. And I got tired of hyperlinking, so if you're curious, go to amazon.com and start looking around for these products.
Even more, as of now my wife and I spend +$250/mo on subscribe and save items we need for our household, this includes baby formula, diapers and wipes, detergent, shampoo and soap, trash bags, dog food, paper towels and more. We use the 5% back credit card and blended save close to 20% on these daily items we need.
In conclusion, on E-Commerce, I expect Amazon to dominate the next decade in retail. They have a massive competitive advantage over other retailers engaged in an omni-channel strategy, therefore it's their game to lose. Furthermore, their competitive edge today will compound into the future and amount to further share gains and a wider moat in years to come.
Cloud Computing: What is this industry, how does Amazon fit in the picture, and why is it such a big deal?
Again, to understand Amazon you'll have to understand what Cloud Computing is. This is not an everyday consumer product/service, therefore it's foreign to most individuals. Second, because the transactions and services are business to business (B2B) it's relatively difficult to determine detailed industry characteristics. What may come as a surprise to you, is it's the most profitable business segment (on a NOPAT basis) and it's also their fastest growing segment.
Cloud computing is the service of providing storage, services, databases, software, security, analytics, artificial intelligence and infrastructure through the internet. There was a time when most businesses built their own server racks, and maintained their own infrastructure. Amazon too did this for themselves in building out their own infrastructure to maintain their E-Commerce platform. In time, they naturally sold this service to other firms.
So where does Amazon fit in now? From all indications cloud computing appears to be an arms race. The most recent estimates for market share vary depending on the research provider. The differences lie in what is being measured. There are multiple components of Cloud: PaaS, IaaS, and SaaS. By all accounts, Amazon Web Services is the clear market leader, but they aren't growing as fast as some of their well funded peers like Microsoft and Google.
The available literature on Cloud Computing as a whole is vague. There are important questions to answer regarding structural advantage or lack thereof, who has the competitive edge, or what kind of moats have been built. Amazon's slowing growth rate in Cloud is concerning. Ramped spend in R&D + SG&A during the 2019 fiscal year is encouraging, and these investments will reduce erosion of market share.
While Cloud remains Amazon's most profitable business segment for now, by revenue it's just ~12.5% of sales. Admittedly I am troubled by the amount of information I cannot obtain without significantly paying out of pocket. Nevertheless, given the relative size of this business, I'm comfortable putting the pencil down on AWS for now, and watching the industry closely going forward.
Other Business Segments:
Amazon has other business segments like their own B&M retail stores including Whole Foods, it's 4 star retail chain as well as it's cashierless Amazon Go stores. All of these combined are worth little compared to the market cap, while interesting.. they are insignificant in determining Amazon's value as a business.
What is Amazon worth today?
Herein lies the problem for analysts when the look at Amazon. The most commonly used methods for determining value are off the charts, for the most part Amazon looks like lighting money on fire.
https://preview.redd.it/7iq4kk8hesa41.png?width=1703&format=png&auto=webp&s=e7b8a9fb6090406db8e0ddd51e9e776062b646cd
A simple value oriented investor looks at a trailing P/E of 84.19 and thinks why would I wait 84 years to get paid back?
https://preview.redd.it/d76fratiesa41.png?width=1689&format=png&auto=webp&s=0cc4e3e57054f658a33a7173084e1a5338da1997
Of course, that's too myopic, and value oriented investors who take that approach, quickly learn trailing P/E is the key to building a portfolio of value traps. More sophisticated investors like Joel Greenblatt might recommend using something like ROIC to gauge how much Amazon benefits from reinvesting and building out it's own business.
The problem with that approach is that ROC, ROCE, and ROIC all use some form of GAAP earnings (either NOPAT or EBIT) to backsolve for this return number. If you look at Amazon's Income Statement, and dissect why net income is what it is there's a good reason why most value metrics/ratios don't work for Amazon. They are investing ~3x NOPAT and 60% of Gross profit into R&D. SG&A tells a similar story. What is R&D anyways? One time costs to develop and build out a business. What is SG&A, variable manpower with a significantly lagged ROI when ramped more than 20% YoY.
https://preview.redd.it/15v33d1lesa41.png?width=890&format=png&auto=webp&s=d4562988962ffc48d858a24b2a190b4db65f4c3d
What dawned on me months ago is this.. what if Amazon cut it's R&D to 0, and didn't touch SG&A? P/E TTM drops to ~20x. What happens to sales growth then? It slows.. and eventually converges with GDP, and then falls beyond that. The story of what Amazon's business is, especially E-Commerce, helps shed light on how long it'd take for Amazon's growth to converge with GDP, when they're on the cutting edge of the knife, and most other competitors remain far behind.
What do other institutions believe Amazon is worth?
https://preview.redd.it/wuzx3n6nesa41.png?width=482&format=png&auto=webp&s=959d83285bb9f67715415a9011802e6039d72d2d
There are 45 Wallstreet Analysts covering the stock. On average, their price target is 2170. Based on the share price today, if they're right, you can expect a 15% return. What if the bears are right? You'll lose ~2% rounding down. And the bulls? the highest estimate is 2550, and represents a 35% premium on the stock.
Here's what Morningstar thinks:
https://preview.redd.it/capam6koesa41.png?width=598&format=png&auto=webp&s=b2ae1e2e6b91882f60c01dec9cb983c8439ccfa8
Keep in mind, the last price is a bit dated. Let's pretend Morningstar is right, I like them more than most analysts. You can expect a 22% return.
I don't like wall street analysts, if I did, I wouldn't do this, and I'd just follow their guidance. They are often right, but can be very wrong at times. The problem with wall street analysts is that they are subject to herding, as well as many other behavioral biases and sometimes conflicts of interest.
But assuming they're right, this is an asymmetric long to take, with significant upside today.
I have an estimate for fair value as well. This involves taking the current growth rate for amazon as well as the mean estimate of earnings two years out. However, instead of earnings, I like mean cash flow per share, because it remains undistorted by GAAP adjustments.
Here are the current cash flow per share estimates:
https://preview.redd.it/9e4sgdmqesa41.png?width=773&format=png&auto=webp&s=d878cacc7620af283233c63ab493c6500b55ba0c
Here is my valuation model:
https://preview.redd.it/3pqriw0sesa41.png?width=1694&format=png&auto=webp&s=16810d9c5ad87ca7b10b01ae3cb590e774f28340
Bottom left in yellow: that is the implied value of AMZN shares today, based on the discounted free cash flows.
Bottom middle with a red circle around it, those are my assumptions for long term growth rate and EPS 2 years out.. so TTM 2021 cash flows.
This would imply a 63% upside on the share price today.
Now, I don't think anyone is getting 63% today, for AMZN shares. Admittedly I'd be surprised if you got ~$3100 for AMZN shares in a year. Unfortunately.. this business will probably continue to be misunderstood like it has been for many years until they're done reinvesting a significant portion of their gross profit into building the infrastructure that expands their business. However, that cash flow number will become remarkably close to EPS with R&D turned off. When it does, share price will rocket. Instead of this becoming a one time event, I expect convergence will be gradual over time, which makes it a long term hold.
More on valuation:
I was disappointed but not surprised to find I'm not the only one thinking about valuation in this way. The authors take is similar to mine, and he comes to a similar conclusion as well: ~20x P/E TTM. I've gone through everything the VIC has to say about AMZN and most everything should be available to you as non-members as it is dated. I found message 109 especially compelling:
https://preview.redd.it/g91fx2ptesa41.png?width=1221&format=png&auto=webp&s=4edce5cbfdb19ae88045ad45b574ee1d7ff60694
In Conclusion: I recommend Amazon stock as a long term investment. I believe this is one of the best value propositions available in this market. Regardless of the broader stock market, the secular trends within retail are significant tailwinds to Amazons largest business segment.
Disclaimer: This document is entirely my own work, outside of linked/pictured information above which has been cited. I own a significant amount of AMZN stock personally. I am not responsible for your gains or losses. I may add more information to this document in the future.
Addendum (1/14/20): The most significant risk to this business is political. The election of either Warren or Sanders in November of this year would most certainly affect valuation for this business in the near term. Whether Amazon is actually harmed by political interference is another story. For now, it appears the odds that either of these candidates receives the nomination is significantly below 50%, furthermore, as of now it appears they would be significantly disadvantaged against the orange man. Consider this tail risk.
submitted by soundofreedom to wallstreetbets [link] [comments] EDIT 2: Thank you u/Dmillehe spending his money on Platinum instead of AMZN stock. You're the real autist.
Amazon is going to dominate the next decade. It's a wonderful business trading at a discount to it's true ability to create cash earnings. My thesis is that traditional methods of valuation that work for most companies don't work for Amazon. This misunderstanding between market 'conservatives' or 'traditionalists' .. so called value oriented investors (of which I consider myself a part) is currently reflected in the share price today, and it's a mistake. Second, the firm has reached a point of inflection, where scale will now provide growth of earnings far in excess of growth in sales. This multiyear catalyst provides a fundamental basis for significant share price appreciation.
To understand why Amazon presents such a compelling investment opportunity, one must understand what is currently transpiring in two specific and unique business segments. E-commerce and Cloud Computing. Many of you are probably familiar with at least the former. The latter is foreign territory to most.
E-Commerce: Why Amazon is prepared to conquer the next decade in retail.
Traditional retail or brick and mortar (B&M from here on out) is still the dominant form of consumer spending in the U.S. and will be for some time. As of Q3 2019, total retail spend amounts to $5.4 Trillion dollar for the prior 12 months. E-commerce amounts to merely 11.2% of this amount (on a run rate basis.) While the size remains relatively small, e-commerce is growing in the mid-teens year over year, or now 5% quarter to quarter and the rate of growth is accelerating. The rate of E-commerce growth has doubled in 12 months.
To understand why this is the case, a qualitative evaluation of the differences between the two is critical. B&M requires physical space that is expensive to build and maintain. It requires uniformed, reliable, friendly and knowledgeable staff. It requires the deliberate presentation of inventory and restocking, amounting to a unique challenge to the retailer of determining layout of shelf space, product mix and promotion.
It's costly for the consumer too. They have to drive there, walk in, and find what they are looking for. This requires owning a car or putting up with public transportation. This can take a significant amount of time. There are some hidden costs too, without E-commerce, price discovery is a pain in the ass. Something retailers are keenly aware of. Here's something interesting about humans and economics. In economics, for a long time, we've modeled humans like they're these perfect rational beings. Ideally.. they'll drive down the road to a different store to get 3% off of whatever they're buying. Ideally. And you will do that for a car. But in reality, if it's 3% off a bag of chips, it's not worth the hassle. It's too expensive to go get $.14 of savings when you have to drive another 10 minutes to another grocery, walk in to figure it out if you're actually saving the most money.. consumers don't do that.
Consumers don't engage in price discovery on most of their small dollar purchases, they don't do that with traditional retail, because it's too costly in time and effort. There's too much friction in the trade-off.
The value proposition of E-commerce is that it saves consumers time and money. Getting in the car, loading the kids in the back, driving, parking, and then hunting for what you want, making sure you are getting a fair price, E-commerce throws all of that out the window. The value proposition for retailers too, is that it saves them time and money. There are plenty of retailers currently taking an omni-channel approach to retail, those who want to shop in person get to, those who shop online can do that too.. everybody wins. E-commerce takes the friction out of price discovery on small dollar purchases.
Given the advent of mobile computing more than a decade ago, many big box retailers also adopted a price match strategy, if you can find it online for the same price? Best Buy, Micro Center etc. they'll match it to keep you as a customer. But that's the extent of it, try going to Kroger and arguing with the cashier about Albersons having a 3/$5 deal on Frito Lay Potato Chips.. that ain't happening.
Amazon isn't Ecommerce, they are a part of it. Their strategy is different than the whole. They are technically omni-channel. However the little B&M they've done mostly as R&D experiment, more on Whole Foods in a minute. The Amazon E-Commerce thesis is this: At the end of the day, most consumer purchases are commodity purchases. They are small dollar items that are easily replicated. This segment of retail has yet to be disrupted by E-Commerce until now. It overlaps with specialty retail and big box items almost seamlessly from a logistical standpoint. The revenue streams are more stable than specialty retail, and it presents a massive opportunity in the long run.
I had the chance to speak with a finance manager at Frito-Lay (subsidiary of PepsiCo) years back after Amazon bought Whole Foods. Amazon had been attempting for years to get the same products you see in any Kroger or Albertsons onto their platform. For a variety of reasons, PepsiCo would not play ball with Amazon. It amounted to channel conflicts between the big established players vs. the disruptive incumbent. What Pepsico had done to Amazon, had been done by Proctor and Gamble, Nestle, Kellogg, and many more.
The purchase of Whole Foods was a big F U, a "we'll do it live" moment.. a Leeroy Jenkins. So you won't let us into your club? Fine, we'll do it ourselves. Grocer's panicked and for good reason. They were the reason Amazon had been held at bay for so long. They'd used their absolute size for many years to prevent E-commerce retailers from getting the same product mix at the same price online. Amazon responded by entering their territory, in buying a physical grocery chain. Grocer's fear was real and warranted, however the truly brilliant component of this purchase was that Amazon purchased for themselves a supply chain for grocery and private label products (365 brand.) Fast forward a couple years and Amazon now has over four hundred private label brands, more than twenty three thousand individual SKUs and 1.4 Million reviews of these products/brands. That entire article is worth a thorough read. Each product line represents a moonshot where amazon can collect both sides of margin on a private label product that disrupts traditional brands. Often it goes well, sometimes it does not, but the platform allows them to poke holes in each product category, and cannibalize the producer surplus of other more expensive branded product in the process. They don't have to advertise, market or promote any of this either.. yet it's already getting plenty of attention.
Here is a compelling example of how Amazon can undercut a premium brand with it's store brand knock off. And there's nothing Allbirds can do about it.
Amazon has built out an infrastructure of warehouses (which are relatively cheaper to maintain on a $/sf basis than traditional B&M retail space) and delivery drivers to meet the daily needs of consumers accustomed to B&M retail. They've disinter-mediated the entire process. You do not need a car, you don't have to be nice to the person behind the counter, or go hunting for that specific product you need on aisle 9, or check to see if the price is competitive or on deal. You can just type it in to your phone in 5 seconds, and see quickly who has the best deal. Turns out (and this is from experience) 9/10 times Amazon has the best deal and they'll ship it that day or the next.
For the consumer, it amounts to savings in both time and money. What the data shows is that we are experiencing rapid change in slow motion. E-commerce is growing explosively here in the U.S. however it's still of relatively small scale, that it will take some time before eclipsing B&M retail. Second, the data shows this rate of growth is accelerating, and has doubled in the last year or so. Traditional retail is not going to disappear entirely either. There are plenty of Amazon proof businesses for now. Hair salons, vets, dentists, nail salons, along with restaurants and apparel to a certain extent.
This online E-commerce platform has allowed Amazon to build out a peripheral advertising business in search. The search component allows Amazon to promote it's own store brand product alongside the branded counterparts. Second, it's able to sell web page space to branded products. Google currently dominates the search game, but Amazon is in 2nd place and stealing market share.
Finally, Amazon has rolled out a wonderful product called Subscribe and Save. Within this platform, Amazon is able to offer 15%-20% savings on everyday commodity items in exchange for a commitment to purchase at a monthly frequency (and it can be cancelled at any time.) What Amazon has discovered is that subscription purchases are relatively sticky. In exchange for a soft commitment from consumers that is relatively stable and predictable, Amazon can actually lower the cost of goods to the consumer. In turn, they are also able to optimize logistically for these sales as they can plan far in advance for them. Second, this allows them to relay demand information to other merchants as well. Example: Amazon can remit data to Tide, and let them know how many pods they expect to need in the coming months based on subscription commitments. Both Tide and Amazon are able to lower CoGS because they have more time to plan for those costs.
Furthermore, if you have an Amazon Credit Card through Chase bank, you get an additional 3%-5% all purchase at Amazon & Whole Foods.
The combination of all of these benefits as a platform amounts is an incredibly compelling value proposition to consumers. As of June this year Amazon has accumulated 105 Million Prime Memberships in the United States, and it is the largest paid subscriber base of any company in the United States period.
One of the luxuries I enjoy in my occupation is that my employer has a very long investment time horizon & high risk tolerance. What this allows is for us to kick back, put our feet on the table and think about what the world will look like in 10 years and how we'd consider being a part of it.
So here's a thought experiment, what do you think the retail experience for consumers looks like in a decade? Here's my prediction. Consumer's buy the vast majority of the things they need online, and they receive it within a few hours to a day, and they're spending less than ever before on what they need. This is already happening, and It's grabbed the attention of people like Jim Cramer, as well as Fed Chairman Jerome Powell. Albeit, E-Commerce is relatively small for now, but the rapid transformation is already causing ripple effects across retail. In 10 years, my thesis is that E-commerce becomes the largest component of total retail sales and Amazon remains the largest component of that segment, as it is today. Additionally, they probably steal share and grow at a faster pace than E-commerce as a whole, as they have done over the last several years.
Personal anecdote:
I'm sitting here in my home office wearing Amazon branded Jeans. I've got 10+ Amazon branded undershirts upstairs, along with 5+ pairs of Amazon Synthetic Golf Shorts. In my house, we've got Amazon branded batteries, note cards & printer paper, detergent pods, echo devices, cameras and more all over the place. There's more too, but I'm not going to list it all. In my experience, what they make is just as good if not better than the branded counterpart, and they do it for less, often a lot less. And I got tired of hyperlinking, so if you're curious, go to amazon.com and start looking around for these products.
Even more, as of now my wife and I spend +$250/mo on subscribe and save items we need for our household, this includes baby formula, diapers and wipes, detergent, shampoo and soap, trash bags, dog food, paper towels and more. We use the 5% back credit card and blended save close to 20% on these daily items we need.
In conclusion, on E-Commerce, I expect Amazon to dominate the next decade in retail. They have a massive competitive advantage over other retailers engaged in an omni-channel strategy, therefore it's their game to lose. Furthermore, their competitive edge today will compound into the future and amount to further share gains and a wider moat in years to come.
Cloud Computing: What is this industry, how does Amazon fit in the picture, and why is it such a big deal?
Again, to understand Amazon you'll have to understand what Cloud Computing is. This is not an everyday consumer product/service, therefore it's foreign to most individuals. Second, because the transactions and services are business to business (B2B) it's relatively difficult to determine detailed industry characteristics. What may come as a surprise to you, is it's the most profitable business segment (on a NOPAT basis) and it's also their fastest growing segment.
Cloud computing is the service of providing storage, services, databases, software, security, analytics, artificial intelligence and infrastructure through the internet. There was a time when most businesses built their own server racks, and maintained their own infrastructure. Amazon too did this for themselves in building out their own infrastructure to maintain their E-Commerce platform. In time, they naturally sold this service to other firms.
So where does Amazon fit in now? From all indications cloud computing appears to be an arms race. The most recent estimates for market share vary depending on the research provider. The differences lie in what is being measured. There are multiple components of Cloud: PaaS, IaaS, and SaaS. By all accounts, Amazon Web Services is the clear market leader, but they aren't growing as fast as some of their well funded peers like Microsoft and Google.
The available literature on Cloud Computing as a whole is vague. There are important questions to answer regarding structural advantage or lack thereof, who has the competitive edge, or what kind of moats have been built. Amazon's slowing growth rate in Cloud is concerning. Ramped spend in R&D + SG&A during the 2019 fiscal year is encouraging, and these investments will reduce erosion of market share.
While Cloud remains Amazon's most profitable business segment for now, by revenue it's just ~12.5% of sales. Admittedly I am troubled by the amount of information I cannot obtain without significantly paying out of pocket. Nevertheless, given the relative size of this business, I'm comfortable putting the pencil down on AWS for now, and watching the industry closely going forward.
Other Business Segments:
Amazon has other business segments like their own B&M retail stores including Whole Foods, it's 4 star retail chain as well as it's cashierless Amazon Go stores. All of these combined are worth little compared to the market cap, while interesting.. they are insignificant in determining Amazon's value as a business.
What is Amazon worth today?
Herein lies the problem for analysts when the look at Amazon. The most commonly used methods for determining value are off the charts, for the most part Amazon looks like lighting money on fire.
https://preview.redd.it/7iq4kk8hesa41.png?width=1703&format=png&auto=webp&s=e7b8a9fb6090406db8e0ddd51e9e776062b646cd
A simple value oriented investor looks at a trailing P/E of 84.19 and thinks why would I wait 84 years to get paid back?
https://preview.redd.it/d76fratiesa41.png?width=1689&format=png&auto=webp&s=0cc4e3e57054f658a33a7173084e1a5338da1997
Of course, that's too myopic, and value oriented investors who take that approach, quickly learn trailing P/E is the key to building a portfolio of value traps. More sophisticated investors like Joel Greenblatt might recommend using something like ROIC to gauge how much Amazon benefits from reinvesting and building out it's own business.
The problem with that approach is that ROC, ROCE, and ROIC all use some form of GAAP earnings (either NOPAT or EBIT) to backsolve for this return number. If you look at Amazon's Income Statement, and dissect why net income is what it is there's a good reason why most value metrics/ratios don't work for Amazon. They are investing ~3x NOPAT and 60% of Gross profit into R&D. SG&A tells a similar story. What is R&D anyways? One time costs to develop and build out a business. What is SG&A, variable manpower with a significantly lagged ROI when ramped more than 20% YoY.
https://preview.redd.it/15v33d1lesa41.png?width=890&format=png&auto=webp&s=d4562988962ffc48d858a24b2a190b4db65f4c3d
What dawned on me months ago is this.. what if Amazon cut it's R&D to 0, and didn't touch SG&A? P/E TTM drops to ~20x. What happens to sales growth then? It slows.. and eventually converges with GDP, and then falls beyond that. The story of what Amazon's business is, especially E-Commerce, helps shed light on how long it'd take for Amazon's growth to converge with GDP, when they're on the cutting edge of the knife, and most other competitors remain far behind.
What do other institutions believe Amazon is worth?
https://preview.redd.it/wuzx3n6nesa41.png?width=482&format=png&auto=webp&s=959d83285bb9f67715415a9011802e6039d72d2d
There are 45 Wallstreet Analysts covering the stock. On average, their price target is 2170. Based on the share price today, if they're right, you can expect a 15% return. What if the bears are right? You'll lose ~2% rounding down. And the bulls? the highest estimate is 2550, and represents a 35% premium on the stock.
Here's what Morningstar thinks:
https://preview.redd.it/capam6koesa41.png?width=598&format=png&auto=webp&s=b2ae1e2e6b91882f60c01dec9cb983c8439ccfa8
Keep in mind, the last price is a bit dated. Let's pretend Morningstar is right, I like them more than most analysts. You can expect a 22% return.
I don't like wall street analysts, if I did, I wouldn't do this, and I'd just follow their guidance. They are often right, but can be very wrong at times. The problem with wall street analysts is that they are subject to herding, as well as many other behavioral biases and sometimes conflicts of interest.
But assuming they're right, this is an asymmetric long to take, with significant upside today.
I have an estimate for fair value as well. This involves taking the current growth rate for amazon as well as the mean estimate of earnings two years out. However, instead of earnings, I like mean cash flow per share, because it remains undistorted by GAAP adjustments.
Here are the current cash flow per share estimates:
https://preview.redd.it/9e4sgdmqesa41.png?width=773&format=png&auto=webp&s=d878cacc7620af283233c63ab493c6500b55ba0c
Here is my valuation model:
https://preview.redd.it/3pqriw0sesa41.png?width=1694&format=png&auto=webp&s=16810d9c5ad87ca7b10b01ae3cb590e774f28340
Bottom left in yellow: that is the implied value of AMZN shares today, based on the discounted free cash flows.
Bottom middle with a red circle around it, those are my assumptions for long term growth rate and EPS 2 years out.. so TTM 2021 cash flows.
This would imply a 63% upside on the share price today.
Now, I don't think anyone is getting 63% today, for AMZN shares. Admittedly I'd be surprised if you got ~$3100 for AMZN shares in a year. Unfortunately.. this business will probably continue to be misunderstood like it has been for many years until they're done reinvesting a significant portion of their gross profit into building the infrastructure that expands their business. However, that cash flow number will become remarkably close to EPS with R&D turned off. When it does, share price will rocket. Instead of this becoming a one time event, I expect convergence will be gradual over time, which makes it a long term hold.
More on valuation:
I was disappointed but not surprised to find I'm not the only one thinking about valuation in this way. The authors take is similar to mine, and he comes to a similar conclusion as well: ~20x P/E TTM. I've gone through everything the VIC has to say about AMZN and most everything should be available to you as non-members as it is dated. I found message 109 especially compelling:
https://preview.redd.it/g91fx2ptesa41.png?width=1221&format=png&auto=webp&s=4edce5cbfdb19ae88045ad45b574ee1d7ff60694
In Conclusion: I recommend Amazon stock as a long term investment. I believe this is one of the best value propositions available in this market. Regardless of the broader stock market, the secular trends within retail are significant tailwinds to Amazons largest business segment.
Disclaimer: This document is entirely my own work, outside of linked/pictured information above which has been cited. I own a significant amount of AMZN stock personally. I am not responsible for your gains or losses. I may add more information to this document in the future.
Addendum (1/14/20): The most significant risk to this business is political. The election of either Warren or Sanders in November of this year would most certainly affect valuation for this business in the near term. Whether Amazon is actually harmed by political interference is another story. For now, it appears the odds that either of these candidates receives the nomination is significantly below 50%, furthermore, as of now it appears they would be significantly disadvantaged against the orange man. Consider this tail risk.
