Amazon a house of cards?

Investment Analysis Clubs Saul’s Investing Discussions
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Someone on the Amazon board was saying that Amazon was a house of cards, had never made any money, and probably never would:

I am curious of the thought process on if Amazon continues to lose money, break even or make virtually no net profit if they keep investing for the next 10,20,30 years? What is the investment philosophy for a company that could potentially go many more decades (they have gone two already) without ever really making a net profit or paying a dividend?

They went on to say that AWS would probably be commoditized. While some think AWS is a holy grail I think we are going to find it is not to dissimilar to any hosting provider that has come before and the end has not been spectacular (Exodus, rackspace). It is a highly commoditized and competitive space where prices rapidly fall.

And that Amazon’s operating cash flow and free cash flow were just bookkeeping tricks and weren’t real, and their PE is ridiculous, etc. Now I (Saul) have heard these same arguments for so long, for so many years, actually, I’m really fed up with them. Don’t they ever get tired of saying that and defying the reality of what’s actually happening? I responded to the post as follows:

The trouble is that all the smart guys were making these same objections, and proving by their calculations that Amazon had no real cash flow, back about nine months ago when I bought my position at $550, (it’s up 47% in those nine months to $808 today).

In fact the really smart guys were pointing out that Amazon had no earnings, and probably never would, when it was at $26 in June of 2006, and the really, really, smart guys were pointing this out when Amazon was at $6 in August of 2001.

I’m not exaggerating! They really were saying the same things back then!

Saul

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In fact, I was reluctant to buy it myself for a while because Bezos seemed to be uninterested in profits, but I reconsidered.
Saul

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Saul,

Amazon like Tesla today is an ultimate “Rule Breaker” stock. Even more than 15 years later the critics are harping on the same things over and over and over again. The company never listens of course and investors who just bought and held just smile.

AOL derided over its free floppy disks, Microsoft, rightly so, over control-alt-del, and so on.

As I stated in a previous post watch out for a true bubble, and the #2 thing is to watch out for a technological or business model disruption. AOL is the easiest example, dial-up to broadband, MSFT desktop changed to internet and then mobile as the dominant computing devices. That is what takes down a company like this, not its critics. Not even government, although AMZN could face antitrust issues in its future at some point. That is no reference to Trump or any future president, just a comment on how dominant AMZN has become.

These critics are one of the top things that you want to see from your investments. Of course these rules are not monolithic, but nearly so. Derision is not absolutely required for a company to be superb, but it helps an awful lot.

Tinker

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Absolutely right, Tinker.

Individual stocks have a habit of climbing a wall of worry.

Jim

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I’m not exaggerating! They really were saying the same things back then

I followed this company closely. I admired them but never bought the stock. I am just not comfortable with the valuation. I guess it takes a completely different mind set to buy Amazon. That’s why I forced myself to join in Rule Breaker, but I am sad to admit, I ended up buying not a single recommendation.

I guess the easiest thing for someone like me may be to buy a fund or ETF for these kind of stocks and allocate 5% and basically write off 5% mentally and let the dice roll.

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In fact the really smart guys were pointing out that Amazon had no earnings, and probably never would, when it was at $26 in June of 2006, and the really, really, smart guys were pointing this out when Amazon was at $6 in August of 2001.

Back then I pointed out to my friend that they lost money on every book they sold. He asked how they made money. I said “Volume, volume, volume!” :wink:

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<<<Back then I pointed out to my friend that they lost money on every book they sold. He asked how they made money. I said “Volume, volume, volume!” ;-)>>>

I remember back at MBA school, a discussion was had as to how Amazon could have such a high valuation as it had exceeded $30 billion and then some in market cap. This was 1999 or so.

One answer was that Amazon is building out a business model that can scale faster and cheaper than any retailer before it ever could, or will be able to in the future.

The other was you cannot value it on earnings, but on value. Do you value a diamond, or a great work of art based upon how much it earned in the past year? No. You own those items based upon how much it will be worth in the future. So you had to value Amazon based upon what its business would be worth in the future. And sure enough, Amazon is still building that business, and therefore you still cannot value Amazon based on earnings.

Turns out in retrospect, and of course the “smart” money was only justifying things and never invested and held, both reasons were exactly correct, and is still correct.

Good lesson for other investment opportunities as well. One that comes to mind is Netflix. Oh the crap Netflix took for its high valuation based upon earnings. Tesla is another such business at present.

If it is a business that is building a franchise, then it is building its asset year after year after year, making itself more valuable every year.

Is Shopify that sort of business? Twilio? Zen? UA? SKX? Not saying yes or no to any of those, just pulled those two from the hat as my mind is too distracted with other things to pull current smaller cap examples. But I do think that is one reason the conventional wisdom gets these companies all wrong. They look at earnings and forget a growth business is about growing its asset, called the end value of the business, not about building cash flow for one year. Thus, why a high P/E or none at all is often simply answering the wrong question. And that is without any new economics, or justifications, it is simple economics.

Tinker

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If you evaluate Amazon based on Graham and Dodd you’ll never buy the stock. As Tinker says, Amazon is a rule breaker. I only started buying last year after listening to Jeff Bezos explain the business.

One of the points of contention is that Amazon uses all the profit to grow the company. Many people, myself included, have argued that you have to show a profit that you then reinvest. Later I realized that this was not true. In Silicon Valley you write off R&D as a current expense instead of capitalizing it and then writing it off over the useful life of the project. Amazon does a huge amount of R&D to develop many of its products like AWS, Alexa, and Kindle. The R&D write-off is giving Amazon a 30% subsidy to grow the business!

Denny Schlesinger

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I remember back at MBA school, a discussion was had as to how Amazon could have such a high valuation as it had exceeded $30 billion and then some in market cap. This was 1999 or so.

Hi Tinker,
The stock did fall 95% or so in 2000 when the internet bubble broke.

If it is a business that is building a franchise, then it is building its asset year after year after year, making itself more valuable every year. Is Shopify that sort of business? Twilio? Zen? UA? SKX?

It seems to me that Amazon, Shopify, Twilio, are building a lot of recurring income (ie a franchise). UA and SKX not so much. When they sell you a pair of shoes this year, it doesn’t mean you will renew next year. You may buy your pair of shoes from someone entirely different next year.

Saul

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<<<The stock did fall 95% or so in 2000 when the internet bubble broke.>>>

Yes, my biggest corollary, make sure the stock is not in a bubble.

I define a bubble as a valuation divorced from reality based upon total market opportunity/marketcap adjusted for risk.

As for example during this period of time Juniper Networks reached a market cap of more than $50 billion. Analysts put out financial forward looking projections of $X and then put out a buy. At these very aggressive forward projections Juniper had only a small future return over the next 10 years based upon the $50 billion market cap it had. It was absurd.

QCOM went to more than $300 billion, with one analyst projecting that QCOM would be the world’s first trillion dollar company. On a risk adjusted basis, it was absurd.

Same with AMZN, but not at $30 billion market cap. I don’t recall how far AMZN fell, but I think $15 billion was as low as it fell (maybe it fell further), but point being that had you bought AMZN in a none-bubble valuation (say in mid-1999) and just held, through all the tremendous swings your returns would greatly exceed your returns trading in and out. Easier said than done of course.

Your returns on QCOM would be maybe nothing over the last 15 years (if you hadn’t bought during the bubble).

Same with AMZN when it bubbled, etc.

Nothing is ever simple. Identifying a bubble is one of the key elements to long-term buy and hold (and sell) investing I believe.

Tinker

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Btw Lesson on the topic of “stop kicking yourself if you missed Amazon.”

QCOM went up 26 fold in 1999. I got 8x of that. Thereafter, had you just held, you’d be about break even I think (without looking at the chart, but its market cap is not more than $60 billion or so it pretty much pivoted at thereafter through the bubble) for 16 years.

Just because a company did that, does not mean it will continue to do that.

However, opportunities to develop. Post bubble QCOM fell to a bottoming level (As it turns out). I did a discounted cash flow on the enterprise on QCOM, and gobbled up 33% of my portfolio with it. I did the same with ARM at the same time, another 33%. Both stocks tripled over the next year or so. I then sold them.

I sold QCOM because of 4G, discontinuous innovation and 3G growth ending.

I sold ARM because 3G wireless growth had mostly ended and 4G was a few years away. Mistake, as ARM did nothing for awhile, but sure enough, just as the next discontinuous innovation took place (4G) and mobile computing, ARM took off again.

Few examples there I guess. The easiest is again following the discontinuous innovation, and not sticking with the legacy vendor who has no real advantage in the next level of innovation that will come to dominate the market.

Good rule there I think, again, for long-term buy holders, as to when it may be time to sell. (1) real bubble, (2) growth in core market slows and discontinuous innovation inevitable.

Converse for when to buy such companies like ARM. ARM chips dominated, but the discontinuous innovation was inevitable, but the market never makes it easy, you had to wait a few years for this to be reflected in the share price.

Today, the discontinuous innovations are cloud, eCommerce (still and accelerating due to mobile computing and greater internet penetration) as examples. Autonomous driving is one in the future.

May be fun to put together a few others. But my brain is fired at the moment and does not want to stretch.

Tinker

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Yes, my biggest corollary, make sure the stock is not in a bubble.
All bubbles are found in the rear view mirror
I can’t wait until everyone will be driving in a driverless car. Since we can only see the bubble while looking through the rear view mirror and not through the windshield, it would be a lot safer if the car knew how to drive itself so we could pay more attention to looking for bubbles.

b&w

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All bubbles are found in the rear view mirror

Not necessarily. This is from November 1999:

The Law of Averages tells me that since the historic growth rate of the market is about 12%, eventually the current euphoria has to settle itself down so that we can get back to the historic rate. As a matter of fact, it is quite possible that we might have a bit of a negative growth rate for a short while (there I go dressing up the naked truth so it does not catch a cold). It is quite possible that this time it really is different and that the bubble will never burst (now the naked truth is fully clothed!).

Unfortunately I was a novice investor at the time and despite recognizing the bubble I did the wrong exit. Here is the link to the full article:

November 29, 1999

Bulls, Bears and Chickens

We are all in a party mood. The world is bright and we are brighter because we are lit by the everlasting brightness of our Gilder star. But there is a nasty Law of Averages lurking out there waiting for the unwary. How many of us are prepared to meet the Law of Averages?

http://softwaretimes.com/files/bulls,%20bears%20and%20chicke…

Denny Schlesinger

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http://www.cnbc.com/2017/01/24/alibaba-reports-fiscal-third-…

Looks like Alibaba is on to something. Lots of growth for such a large entity. Perhaps it is the next Amazon, but the Amazon of even larger China.

Tinker

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I sold QCOM because of 4G, discontinuous innovation and 3G growth ending.

I sold ARM because 3G wireless growth had mostly ended and 4G was a few years away. Mistake, as ARM did nothing for awhile, but sure enough, just as the next discontinuous innovation took place (4G) and mobile computing, ARM took off again.

QCOM and ARM were completely different, in my view.

QCOM was, and is, a wireless modem play. So it made sense that QCOM’s 3G patents wouldn’t help them in a 4G world. That said, they did come up with some good 4G technology and still have a lock on some areas.

However, ARM is raw CPU, it’s not wireless modems. ARM chips are in all kinds of processors, even ones without wireless connectivity. So, associating ARM success based on 3G/4G wireless technology transitions, was a non-sequitor.

The problem with ARM was that its business model was too friendly. ARM almost killed Intel, and there was and is no way Intel could ever compete with ARM’s licensing and build it yourself model. Problem was that ARM’s model was not a way for them to rake it the really big bucks. So, it was hugely successful in terms of adoption, but not profits. Not bad, mind you, but not at the scale of an INTC or QCOM or NVDA.

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The problem with ARM was that its business model was too friendly.

Fool DirtyDingus called ARM a gentler, kinder gorilla. Would a more aggressive business model have been as successful? ARM had lots of competition in the early days and there was the opinion that customers would not be willing to pay killer royalties.

Denny Schlesinger

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Fool DirtyDingus called ARM a gentler, kinder gorilla. Would a more aggressive business model have been as successful? ARM had lots of competition in the early days and there was the opinion that customers would not be willing to pay killer royalties.

Maybe we will see under SoftBank. It looked as though a more aggressive gorilla approach was working for Qualcomm until it got busted for being a serial abuser of IP rights.

A

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Looks like Alibaba is on to something. Lots of growth for such a large entity. Perhaps it is the next Amazon, but the Amazon of even larger China.

At a market cap of over 260B, one might say it already is like Amazon…so much for “the next.”

I’d rather invest in the real Amazon.

Bear

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Noted short seller Jim Chanos doesn’t like BABA’s accounting FWIW.

Rob

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At a market cap of over 260B, one might say it already is like Amazon…so much for “the next.”
Not at all Bear. With respect - for BABA’s 260B you are getting the equivalent of Amazon (400BN), Youtube (est. valuation 100BN) via its ownership of YuKou, eBay (40BN) via its AliExpress & Taobao auction sites, PayPal (50BN) via its earnings stake in AntFinancial/AliPay.
Then factor in China never built an offline retailing commerce equivalent of WallMart etc - but instead of a belated nationwide physical retailing build out, Chinese are going straight to online commerce so BABA is actually also the equivalent of US’ Walmart to a degree.
Then factor in China has 3x the population of the US…
Then factor in China is growing 2x the rate of the US economy…
Then factor in its assets in India (another 1Bn people) and SE Asia (another 1Bn people)…
Then you have all their strategic initiatives like AliHealth thrown in for free.

I’d rather invest in the real Amazon.
That’s fair enough but judge it on its merits. Sure there are more risks with BABA but its valuation is a long way behind Amazon or the real direct equivalent on a like of like basis in my view.

Ant