Reflections on my investing.

Investment Analysis Clubs Saul’s Investing Discussions
21

fwiw, I was commenting on valuation, I was commenting on your observation that ‘It’s just starting to actually turn a profit and is levered to the hilt’.

I was just looking at the BS on 12-31-15 (the Q3 16 is similar) and saw

  • 15.89b cash
  • 3.918b marketable securities
  • 8.235b in debt

Or 11.5b in net cash. How is that levered? SE is actually 13.384, so where are your numbers coming from? Are we looking at the same things? I’m honestly confused by your note.

fwiw, your share count is off too - the latest diluted count as of the Q3 release was 485, though I’m not sure how many anti-dilutive are excluded (only looked at the Q3 release, not the Q.

On your other comments, I’m good with all of it. Confused - esp. since if you look at that same release you’ll see operating cash flow still growing at near a 50% pace - which explains the valuation to me, even though nobody argues this is cheap (I don’t own it).

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22

typo I meant: I WASN’T commenting on valuation, I was commenting on your comment

23

last 2c

Amazon isn’t being valued on earnings - and it shouldn’t be. They are voluntarily choosing to spend at the level they are to gain market share, they are succeeding beyond anybody’s wildest dreams. Plus, given the nature of the biz model - the upfront payment they get in the biz - operating cash flow is consistently high regardless of net income does, so the business will continue to generate money that can be reinvest - in a virtuous cycle. Some of that was good fortune - the AWS side is really incredible and largely responsible for the latest moves in the valuation - but focusing on the income statement exclusively will lead to a lot of erroneous conclusions.

At least, that was the mistake I made for a very long time cause I wasn’t paying attention all three financial statements, not just earnings.

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24

a final follow-up

Amazon did 24.2b in operating cash flow from 2013-2015
“Earnings” includes depreciation (14.3b) and stock based comp (4.7b), both of which are non cash charges
There was also a large expansion in accounts payable over the same period (again, nature of the biz model here), so that’s another source of cash. They voluntarily did 12.9b in CapEx, but CapEx only grew by 33% while OCF grew by 113%. If this trend continues, then OCF gets even larger, CapEx remains in a steady state, and the BS practically gushes with cash, so much cash they won’t know what to do with it.

On your valuation argument, they merely have to do a multiple of those numbers. Given that US Treasuries are 2.5% right now, if you slap a 400b valuation on Amazon you need to reasonably believe they will do 20b in FCF (5%) and in the last TTM they did 8.6b. You don’t need heroic assumptions to make this work, but clearly Amazon has to continue to put up big fat numbers but they haven’t slowed down yet and there is a lot of share to gain, esp. if they can grow overseas.

Course, eventually the company will need to be broken up on anti-trust grounds, but that’s another day.

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25

Their total debt is in the neighborhood of 4 times their stockholder’s equity.

…

Here’s my big problem. Its the valuation problem that most Amazon fans know well and choose to discount as irrelevant.

I must quibble with that statement, I doubt that AMZN investors are gamblers as the statement implies, maybe they calculate the valuation differently.

In case someone hasn’t seen it in a while, let me recap it briefly.

As I write, AMZN is trading at about $839 per share. They have 475 million shares outstanding. That’s a market cap just short of $400 billion. I look at their balance sheet and see $70 billion of assets. (Frankly pretty good assets, too. Only a small amount is goodwill from previous acquisitions.) So I need to believe that there is $330 billion of goodwill baked into all of their systems - marketing, distribution, AWS, and everything else. That’s a lot of goodwill - 3/4 of their current price.

That would make Price to Book (P/B) = 5.7.

Consider the following: a lot of Amazon’ assets are the result of R&D which is expensed, not capitalized so it does not show up in book value. Additionally, since the R&D is expensed, it is tax deductible at the rate of around 30%. Taking these two items into consideration, P/B could be half of your figures. If these assets are highly productive then the valuation is not crazy at all.

Are they productive? You seen to think so:

I was also going to say something stupid like it would take years of profitability to offset all of the accumulated losses. But that’s not true either. The profits in the last few years have already wiped out their accumulated losses since inception. Which means they’ve finally generated a net profit over their existence.

The latest 10-Q says:


**Retained earnings** 
**September 30, 2016  December 31, 2015** 

    $4,167,000,000     $2,545,000,000

Maybe AMZN investors are not gamblers after all, they just calculate valuation differently than you do. :wink:

Denny Schlesinger

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26

Amazon isn’t being valued on earnings - and it shouldn’t be.

I’ve got to disagree with this. Ultimately, that’s all you have to value - what the business earns.

I agree there are problems with GAAP accounting, just like there are problems with IFRS accounting and cash accounting. You need to understand the strengths and weaknesses of whatever accounting system you are using, and how those weaknesses show up in the particular company you’re analyzing.

As Denny correctly points out, one weakness for Amazon is their R&D spending. All three of the above accounting systems require R&D to be expensed currently. (OK - I’m not quite as sure about IFRS, as I haven’t done much CPE in that area. But I’m certain about the other two.) And Amazon spends a lot on R&D. Hopefully, that spending will come back in future years as increased revenue.

As a CPA, I find it hard to ignore earnings. I see the cash flow statement as a way to answer questions like “If they earned so much, where did the cash go?” or “What did they do with all the money they borrowed?” or “How are they still in business when they’re losing money?” I have to admit that after preparing so many cash flow statements over my career, I have become a bit jaded. I sometimes see the cash flow statement as a simplified statement for people who can’t understand the balance sheet and income statement at the same time. On the other hand, I don’t have as much of a problem with the idea of “adjusted earnings” that don’t conform to GAAP, providing I can understand the business reasons those adjustments need to be made. Those can become very helpful in understanding the performance of a particular business.

At any rate, I need to bow out of this discussion of Amazon and get back to work. I’ve learned a bit through the discussion and I thank you all for that.

–Peter

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27

I look at their balance sheet and see $70 billion of assets.

Hi Peter, Just wondering if they own the land that all those distribution centers and data centers are on, and if so, are they carrying the land at cost instead of current value, and if they have marked down the value of the buildings, which may also be appreciating in value. That might make you a little happier. (smile)

Saul

28

Ultimately, that’s all you have to value - what the business earns.

that would be true if earnings equaled the same thing as cash generated by the business, but obviously you know that isn’t true. It is too easy to manipulate ‘earnings’, and with adjustments for this and adjustments for that but it is mighty hard to mess with cash flow and the results that show up on the balance sheet. Another thing - there are advantages to companies that generate high cash flow in relation to earnings - take deferred income, for example. Getting the money upfront is good - getting paid early is ALWAYS good. Float is good for Warren Buffett too - he talks about it incessantly, but you won’t find the value of that float on the income statement.

You can find likely turnarounds in companies generating low earnings and high cash flow. For a clear illustration that I’ve never forgotten - look at the annuals for Dillard’s going back to 2010 - company was left for dead but they were hugely cash flow positive while earnings eh cause the DA was so much higher than the CapEx. They weren’t going anywhere, and when they did turn the stock ended up moving 10x. Knowing the results would get better wasn’t so predictable but realizing they weren’t going anywhere was.

End for me too.

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29

one last thing - just to beat this horse good and dead

NOL don’t show up on the income statement - they are nowhere to be found. NOLs occur when a company loses a lot of money and gets to use that writeoff in the future if they ever get profitable. But if they are expecting to use the NOL, they have to start provisioning for the income tax on the income statement - even though the tax is absolutely fictional. This is easily viewable both on the balance sheet (where the NOL becomes an asset) but more apparent on the cash flow statement cause there will be a huge difference between the cash generated and the reported income. In essence, the income statement is completely misleading.

Denny’s (restaurant) is a good example of this.

ok, done with this… (hopefully) :slight_smile:

30

If you wanted an intraday quote you called your broker… You weren’t invited to conference calls. There often weren’t even recordings, and never transcripts. You were entirely dependent on your full service broker…

For you youngsters, here are some memories that may amaze you. We are so used to Level 2 streaming quotes. I can remember when you’d ask your broker for a quote (by phone) and he would punch some buttons and wait a few seconds, and then give you the latest bid and asked, and maybe the volume so far. He didn’t have streaming quotes himself. If you wanted to buy 100 shares, he’d take your information down by hand over the phone, walk it over to the teletype machine, or whatever it was, and enter your order. (Talk about high-speed trading!)

If any of you other oldsters remember any of this I’d welcome any corrections.

Saul

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31

Statistically getting out when you are ahead at blackjack is always the wise move. If you are in it to make money.

Getting out of a stock in an uptrend is statistically not a wise move. Until it is.

There is no doubt that momentum is real in the stock market. But often we don’t recognize it until it is about to shift. Momentum exists for the general market , broad indices, and for individual stocks

How to tell an academic- fair deck ,blackjack , your opponent wins 20 out of 20 games . Keep on playing, each game is independent.

common sense- they were lying about it being a fair deck.

32

If any of you other oldsters remember any of this I’d welcome any corrections.

Saul

You forgot to say how expensive it was!

Denny Schlesinger

33

common sense- they were lying about it being a fair deck.

No, people follow the leader which is what creates momentum. Same thing as keeping up with the Jones.

Denny Schlesinger

34

Saul,
It sounds like your gut plays a big part in your decision making.

I’ve always listened to my gut and also the bigger picture, what’s going on around me.

During the dotcom bubble I was living in Monterey, CA. The stories I could share about what was going on in that area because of the paper money being made an hour away in Silicon Valley.

25 year olds buying mansions in Pebble Beach and tearing them down to build bigger homes.
A party of 8 spending 60,000 for dinner and rare wine at Casanovas in Carmel.

I have dozens of mind blowing stories as I had friends in real estate and one was an appraiser.

In December of 1999 I was on the phone with my mother, who was a real estate broker in Palm Beach, Florida. I remember clearly telling her that this was all going to pop, that real estate cannot go up 35 to 50% a year, that not everyone can become millionaires over night, that the law of averages, Mother Nature, someone up there has to correct this insanity. She told me not to be so negative, that things were different. I didn’t get completely out of the market, but I went very conservative, raised cash and didn’t have any major blowups.

Two of my line cooks bought homes in Salinas at the same time. Two guys making 15.00 an hour were buying 379,000 homes with no money down. They discussed it with my brother and I and we told them not to do it. They went ahead with the purchases, pushed by a banker in a small bank in Salinas.

I remember them laughing at me, as if I was stupid, that they were living the American dream and I couldn’t accept or see it. Within a year they both pulled out home equity loans as the homes kept appreciating, and bought brand new cars and a boat. I started to doubt my gut, but I stayed conservative, feeling that the end was near.

About a year later the crack started, interest rates began to climb, that cheap adjustable loan beagn it steady rise to an unaffordable level, and home prices began to crash. Gone were the cars, the boat and then the homes. It was over.

So I go with my gut as well. The reason for the long stories, I’m certain too long, is to share with you that I have that gut feeling again. It’s not that I feel that the market is incredibly overvalued, or there are incredible bubbles out there, and I don’t see a crash right now, but I do see a lot of confusion and fear ahead and I do feel we are in for a very healthy correction.

I don’t like the policies being set forth right now so I’m being very cautious.

Once again I’m listening to my gut, not all the noise that surrounds us.

Chris

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35

Denny
I was talking about games of chance not the stock market.
1,048,576 to 1 the odds of 20 coin flips in a row being heads- starting with the first flip
I was talking about games of chance not the stock market. Well before the 20th flip I would start distrusting the veracity of the coin. Or in the case of blackjack the deck or the dealer. Of course significant “runs” occur in random events too.

36

I was talking about games of chance not the stock market.

I got confused! Sorry.

Denny Schlesinger

37

"No, people follow the leader which is what creates momentum. Same thing as keeping up with the Jones.

Denny Schlesinger"

Very true until the heard runs off the cliff, and there is always a cliff at some point. The trick is to spot when the last few Jones are trying to run with the pack.
In 1987,2000 and 2008 the heard was running with incredible momentum and then the bubble burst and down they went.

Bear markets happen.

Chris

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38

I didn’t have a broker,I had to dive to my local bank sit down with bank person fill out paper work and they placed the order.

39

For you youngsters, here are some memories that may amaze you. We are so used to Level 2 streaming quotes.

Yes, I remember having to call a phone number then having to press the number associated with each letter of the ticker symbol to get a quote. A time consuming process for each stock. Now we have ‘bots’ doing millisecond trades.

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40

Heck ! I remember, when I first started investing in stocks, we had to call our broker and visit about the market in general, then about the company I wanted to buy or sell, then he would make a call to find out the price and by the time the trade was made the actual price might be one or 8 cents different from when I first called and when he returned to tell me what I’d bought or sold there, sometimes, would be $2-$3 difference.

Ahhh, the good ole days before computers were on everyone’s desk … or now in yer hand. Gads !

Rich (haywool)

1 Like