Last week, I asked you if you’d prefer investing in Amazon, Apple, Google or Microsoft for the next 10 years. I said my two picks would be Google and Amazon. Some agreed, while others pointed to Amazon’s sky-high P/E ratio. I know, it’s scary. If Amazon started trading at a more reasonable Facebook-like P/E of 46, the stock would be worth a fraction of what it’s currently trading for.
Amazon Is Difficult To Value Based On P/E
I’ve explained in the past why I use the P/E ratio and in general it has led me to some solid results. It does not work in all cases though and you can see why I have not traded Amazon in my long & short tech stock picks in a while. Amazon continues to do incredibly well based on some metrics but not as well when you look at income, earnings per share, etc.
The Jeff Bezos Way
The issue is that Amazon continues to focus on its underlying business more than any other I can think of. They say that the biggest challenge for companies that turn public is to avoid the temptation to focus on short term goals, objectives, etc. Jeff Bezos clearly doesn’t give a crap. Everything he is doing is built on the very long term.
-Building This Incredibly Complex Shipping & Distribution Network: Not only does Amazon sell through its website but it is now able to ship at little to no cost. Packages get there within a day or two (and it’s getting closer to same day delivery). There is no other company that comes remotely close to this network. The scary part for competitors is that Amazon’s lead is only growing bigger thanks to huge reinvestment in warehouses, robots that automate the actual shipping, distribution centers close to big centers like New York, etc. It’s no wonder that companies like Best Buy (BBY) and Walmart (WMT) are starting to freak out as they lose business to Amazon. Now, Amazon is even working on adding electronic lockers to facilitate life for consumers.
-Vertical Domination: Amazon started dominating the physical book selling business through its website forcing all other big bookstores in the US to close. It is now going one step further with 2 initiatives:
Kindle market (through both its Kindle device and its Kindle apps for other Apple and Android devices), Amazon has completely taken control of the ebook market with close to 90% of the market share.
Publishing business: Amazon is now taking it one step further as it has started publishing its own books, trying to overtake the book publishing business as well. Tim Ferriss, one of my favorite authors who wrote best sellers The 4 Hour Workweek and The 4 Hour Body is now set to publish his next book “The 4 Hour Chef” through Amazon. It will be interesting to see how much success it will get as many top retailers are refusing to sell the book. I’m still convinced it will do extremely well which will certainly be a reality check for those publishers.
-Selling At 0% Margins: In some businesses, Amazon seems determined to grow market share by offering rock bottom prices. In cloud computing, Amazon’s AWS prices are so competitive that it has locked in much of the bigger players such as Netflix. In the exploding tablet business, Bezos confirmed that he was not trying to make a penny in profit by selling the device. Instead, it’s focused on making money when consumers use it (by selling content).
-Prime Service: An already popular service will certainly gain traction as Amazon started offering a monthly fee (instead of the annual one). In return for $7.99 per month, members get access to a “Netflix like” streaming service, free shipping on physical goods and tons of other benefits. How can Amazon make this work? No surprise in the fact that Prime members tend to increase their Amazon spending significantly once they sign up. Win-win?
The Business Will Be A Big Winner.. What About The Stock Though?
The big problem is that even though I’m 100% convinced that Amazon’s business will end up being HUGE and it will continue to transform retail, it’s not as clear what kind of margins and profits it will be able to generate. Thus, it’s a challenge for me to see how high the stock could end up going. There is a lot of upside, but some (others would argue all) is already priced in. First off, I wanted to take a look at the main underlying numbers:[table “465” not found /]
Then you can see the progression in sales:
I’ll show the progression in EPS but I personally don’t give it much value since Amazon is reinvesting so much of its revenues:
In an ideal world, I’d be able to back out most of the reinvestments to get a more accurate profit figure but the reality is that it’s impossible. The entire Amazon business model depends on those prices right now. So as much as I am a believer, in Amazon, I have more trouble justifying the valuation. I still try to find comparables and believe in the long term case, but I’d love to hear your thoughts on Amazon..bull or bear? How do you justify either?