Some disclaimers first. I am a nobody. I don’t have a degree in finance. I have never worked at a sell side, buy side shop or in a hedge fund. I probably never will. I’ve never managed funds. I’ve never “experienced” meltdowns (beyond covid19, and boy were there big errors of omissions).
What I do have is a pessimistic outlook on most things in general and a lot of common sense - which strangely seems lacking almost everyday.
Pessimism helps. 90% of businesses fail. Go through the annals of listed stocks going back 50 years. See what’s happened to most of them.
If the statistic fits, it pays to be highly skeptical. Being skeptical has kept me out of more mistakes than being optimistic. When you’re skeptical, you cap your downside.
Doctors use the minimum effective dose.
Athletes train the minimum they can and try to maximize rest and recovery. Muscles and power gain in recovery, not in training.
The more concentrated your strategy is, whether its chess, dota, starcraft 2, Go, the better it is.
Less is often more. This reflects the way my holdings are laid out.
My holdings are typically placed into two buckets.
In one bucket are the not so expected compounders. These are companies trading at fair or slightly under fair prices. The market typically ignore such companies because the share price is seen as high, the “edge” is deemed as “priced in”, or for a variety of other exogenic reasons. These are the companies that I typically have a hard time killing with fair or even sometimes unfair assumptions.
The second bucket are microcap companies I believe have the ability to go far. These are the prototypical, high risk, high reward companies which can either be a 100 bagger or a zero. The math here makes sense. $100,000 spread over 100 companies with a chance of being a hundred bagger each means I only need to be right once to recoup all of my capital and gain a company that could pay a yield in the future, and if I’m right on more then 2-5% of the companies, I double or quintuple my money.
I can risk very little for very much, much more.
We exist in a world where certainties are uncertain and where uncertainties are certain. Where do you put your money when the odds are so randomized?
For regular old common stocks, it’s rather simple.
Businesses can be split into two categories:
either the dynamics of their industry will change or be disrupted,
or it won’t.
Horses were “disrupted”. Taxi services.
The telephone book.
Airplanes as a form of travel.
A lot of these new fandangled industries were “transformative” and “disruptive”.
But how many of these companies created outstanding, long lasting value for shareholders that compounded steadily year after year?
Don’t confuse disruption with competitive advantages.
Right now, I’m seeing a lot of froth in the markets. I’m seeing Starcraft 2 streamers talk about bitcoin and I’m seeing Youtube MTG streamers talk about buying call options on AMD.
It’s definitely getting weird. Platform brokerages are giving people who sign up w brokerages shares of Apple if they deposit a certain sum of money.
At some point, this will all unwind.
As with any decent investor worth a damn, this is the time to be picking your spots and going over a list of companies you’d want to own if markets take a 50% dive.
On the other side, you need to be picking over things that will be decent long term holds.
That’s why I bought Amazon.
Imagine a global delivery and storage system capable of sending whatever you order, anywhere in the world, within a day, and then eventually, within 2 hours of keying in an electronic order.
How much information and data would that system accumulate over time?
What would be the fixed costs of running such a global system?
What can an operator of such a system do with the eventual mountain of aggregated data/analytics of shipments, medicines, cargoes, food, industrial equipment/electronics?
What are the long term ramifications of such a system being built out, and how would you go about increasing the net value of such a system over each year?
How can this system allow you to “conquer” newer more fertile, yet unoptimized fields?
These are questions that featured on my mind front and center whilst I evaluated the many facets of Amazon as a business.
Here is what I believe.
On a net present value basis, I believe the company trades at fair value if we assume discount rates of 10% , half the growth rates to 15%, and assume terminal growth of 6% via Amazon taking market share from companies w no ability to leverage a better, more efficient, fixed cost global delivery system paired w an insane informational advantage.
I believe Amazon trades at significant discounts if we account for even a slim percentage of material growth prospects in adjacent industrial opportunities in groceries, medicine, vehicles, insurance, advertising, as well as cloud computing/artificial intelligence services.
But why is this growth which is often speculative in nature believable and predictably true for Amazon when it has never been for other companies with similar per unit cost profiles (ie, it costs the business extra money to serve the incremental customer, and so infinite growth cannot be easily achieved)?
I believe that it all comes back to Amazon’s business model.
It has a low cost (cheap items) fly wheel model previously employed by the likes of Costco, Walmart, Ryan Air, previously South West (for reference, items I can typically find in Amazon that I can also find in local electronic stores cost 20-30% less. Sometimes even 50% less - and they ship to me within 2 days.)
The low cost Flywheel Model is supercharged by negative cash conversion cycles that even the best retailers previously mentioned find hard to compete with and,
That gigantic network of distribution affords it information on virtually anything consumption related. Consumption patterns, average amounts of goods an area requires, average new electronic merchandises, vehicles, household FMCGs, et cetera. That information allows Amazon to better position distribution versus its rivals in markets it has conquered (which is how 2 hour delivery has really come about).
All of which feeds back into a marketplace that draws greater amounts of sellers and thus greater amounts of buyers, which thus widens the advantages that Amazon already has and generates incremental compounding value to the top of the chain and then propagates downwards
Note also, Amazon doesn’t really compete with its competitors so much as it enables. Better quality products being sold on Amazon don’t necessarily have to compete on price, and the business structure of Amazon won’t allow it to outcompete care based, customer service heavy industries (auto parts, etc) yet. But this isn’t a bad thing. A constant thing I find amazing about Amazon is that its an everyone wins kind of scenario. Customers get cheaper goods. Suppliers get bigger exposure (200mn Amazon Prime members now). Amazon gets bigger and better. There’s tremendous value in being a business that is symbiotic vs one that crushes the competition.
But this information alone, isn’t new.
As Josh Tarasoff noted prior in his 2012 ValueX Vail presentation on Amazon, the company’s advantages only deepen with its investments and spending. I tabulated a rough count of reinvestment rates and return on incremental capitals invested.
Neat. And the facts are pointing towards greater returns on capital as long as greater scale is achieved.
Note: For those confused about scale economics, simply apply the local delivery problem. You ordered food. The cost to make it worth my time bringing it to you is $10. I could charge you $3 recurring to make the cost free - anytime. And I’ll lose $7 each time. But what happens when your neighbors and friends join? What happens when lets say 1/5 of the 100 people in your block decides to each get on Prime? That’s 20 x $3. $60. Now I’m no longer delivering only one item, but the cost of maintaining a delivery fleet, logistics outpost, drivers, largely stay the same with minimal variation in fixed costs beyond fuel. In the scenario above, let’s call it $30 to maintain that “base of logistics”. I now net a $30 profit. This is only possible if I get big enough, and if there are enough people to share it with. The fun part is that a “logistics base” isn’t just for one neighborhood. It’s for all nearby areas within a circumference. Which means incremental signups via Prime subscription or marginal delivery fees drop directly to the bottom line as free cash flow.
So what is new?
What I think the broader market has failed to realize is that these advantages that Amazon has managed to carve out for itself via its business model is not simply static in nature as it is for most companies - these advantages it has propagates across industries that Amazon enters and at some point will simply “spill over” into the next most sensible “bolt on” industry for its global distribution supply chain as long as it sticks to products that maintain routines of some sort.
This might seem idiotic to point out but consider the following:
Google cannot enter the groceries market.
Facebook cannot enter Netflix’s video streaming on demand market.
Netflix cannot enter Mckesson’s pharmacy distribution market.
Airbnb cannot hope to enter Autozone’s market.
But Amazon can and have entered each of the company’s markets above - and the market doesn’t seem to care or at least doesn’t seem to rate that highly enough in my opinion.
(1) Sales of Amazon will eventually (5-10 years) be a better search engine for physical products at cheaper costs *(though google/youtube will still draw significant viewership for product reviews - note the evidence, rising advertising spending on Amazon marketplaces and rising numbers of prime subscribers plus). Take a look. Do you think this goes higher or lower over time given the nature of the business and the facts at hand? My bet is higher.
(2) Amazon is competing with Netflix’s video streaming -> it’s called Amazon Prime Videos.
(3) Amazon is competing w the likes of Mckesson (MCK). Even with 1% net margins, the truth about the pharmaceutical industry in the US is that people on the ground are effectively extorted on a daily basis (which drives up insurance costs). When there’s loads of excess fats on a system, Amazon should be able to cut across it and deliver greater value. Even assigning a 10% probability of Amazon carving out a 10% market share of this drug chain adds significant value currently unaccounted for in AMZN’s current share price. Lyall Taylor at the LT3000 blog has performed an in-depth dive on the problems facing consumers here.
I hate that I couldn’t invest in MCK, but Lyall’s right. If dropping prices effectively reduce your competitive advantages, something’s broken in the fucking system. This is one area I think AMZN can and will be able to carve out a significant niche over time.
Pembroke Consulting’s Drug Channel Institute CEO Dr Adam Fein argues that AMZN isn’t really changing the drug distribution system but simply entering it, that AMZN relies on insurance from which GoodRX (GDRX) also relies on, which in turn is served by Cigna, and which really only validates the fact that none of what AMZN is doing is really all that “disruptive”.
I am less sanguine on this dynamic.
Amazon brings significant buying power to the table and it’s in their DNA to significantly lower costs for consumers by leverage scale economics shared. No one previously has been able to do this because no one had the scale, the ability to build out an effective distribution chain the way most of the oligopoly has, or the ability to pressure competitive margins.
We can make the argument that the dynamic above (where raising prices raises competitiveness) is something that runs counter to Amazon’s habit of lowering prices, but I really think that would be taking the cake here - there’s no reason to believe Amazon would behave the same way PBMs have traditionally behaved.
To cut short a complicated discussion, I believe (A) Amazon would stretch out tentative feelers into the market with the aim to reduce “fat” in the system where it first can, typically in the uninsured drugs section and then (B) leverage its large earnings power from other markets and focus on cutting off distributors like Mckesson at the knees. If you think that cannot happen, I invite you to look at what happened to diapers.com, Amazon was willing to swallow losses of $200 million per fucking month in order to gain an edge. That is only possible when the engine of your company is built on negative cash conversion cycles and is able to distribute large amounts of cost over an even large base.
People who believe Amazon isn’t going to be able to gain at least some market share within the next 5-10 years are also discounting the fact that unlike other businesses who would probably have to fight tooth and nail for the delivery business of consumers, Amazon already has an in-road - they deliver all sorts of items and adding drugs (a routine consumption pattern is key to increasing the value of a delivery chain, routine adds visibility) is simply a good “bolt-on” and makes intuitive sense after delivering groceries (yet another routine consumption - noticing a pattern here?).
I won’t be surprised if Amazon manages to eke out a small chunk of the drugs distribution business by eliminating pharmacies altogether from the distribution standpoint, at which point what Mckesson stands on is suddenly a delivery route not tailored to deliver to individuals whereas Amazon is tailored specifically for that eventuality.
In other words, the bet on Amazon entering the pharmaceutical industry and killing off drug distributors is not to even engage the distributors at all, but to force the people these distributors serve out of business - why allow that bit of fat to remain? Will people complain when Amazon serves up the same drugs at half to 1/3rd the price?
I like the approach. In Starcraft II, a competitive real time strategy game, a typical game can end where one player (in greater control, with more resources) simply controls the map and avoids engaging the other player. The goal is to starve the enemy of resources. This is similar. And I’m not sure shareholders of distributors realize this yet. If I’m forced to bet on someone, I’d bet on Amazon in this regard.
(4) Can Amazon add a list of hotel stays and experience to its list? Maybe. It can theoretically be done. But I find it unlikely. There’s zero bolt on value to adding a list of cheap places to rent to Amazon’s large network. But adding yet another thing that can be delivered off of Amazon’s large existing logistics infrastructure base does add value - especially when autopart retailers enjoy nearly 17-20% margins conservatively. To cope with that, just as Amazon’s Nation wide telehealth services help people with drug advice, the company should eventually be able to spin up a Nation wide auto-parts telephone service that can offer advice and provide parts, all of which Autozone/O’Reilly does.
This isn’t the focus for now, which means that AZO and ORLY does get significant room to breathe and both companies should deliver significant value ahead as they continue returning capital to shareholders and cementing customer loyalty to brand trustworthiness and consistency - but I DO expect Amazon to one day own a large chunk of the auto-parts business as well starting w the DIY portion (minimal customer service required) and then the more service heavy section following much later.
So if you have everything I’ve just laid out together, you start to get a mishmash of facts that start to point the way towards larger forward growth from Amazon. The reinvestment runway itself is immense - Amazon is something like 1% of global retail and 4% of US retail. Everyday household items that can traverse the tollway Amazon is building out have yet to be added to the mix. None of the current competitors (besides MELI, Etsy, which themselves carve out niches in different areas, one in handmade goods, one in a generally poorer area with a different language base and different cultural norms) have some form of negative CCC to drive larger growth and keep pace with Amazon. Zero.
On a macro level, I would like the reader to consider human incentives. Beyond what had been immediate and obvious, humans have over time aligned themselves in general with incentives.
How long can a perverse system driving rabid drug inflation prices thrive in such an environment? Knowing human behavior, would you bet for, or against it? A large part of my beliefs regarding Amazon is that they do focus on what drives the larger and more significant crowd of consumers.
There’s a much smaller group of people who would privately cheer higher drug prices and greater medical restrictions for people from lower economic stratas.
This is one of those moments which seem rare but in effect happen all the time - yet again we must make moves with certainty in uncertain environments and with imperfect information. I think I’m roughly right. I think the market hasn’t given enough credit to AMZN for what it can do and how far it can propagates its current advantages across commoditized product lines, and how fast it can generate growth. I think the market hasn’t fully understood what it means yet because people as a whole are bad at long term goals and have a hard time comprehending bigger numbers (Walmart, Apple, both are larger than AMZN, but neither is raised as a monopoly, interesting, isn’t it?). I think the true value for AMZN is probably somewhere 10x of where it is today. Maybe time makes me a jester.
But I’m pretty sure I’m roughly right.
At 2% free cash flow yields, the implied payback period is more likely around 70 years considering a discount rate of any kind.
For arguments sake I did a rough NPV of future cash flows based on 2020 free cash flow per share of $60.82. At 15% growth and using a 10% discount rate, the NPV implies a payback on investment in about 28 years. Or about a 3% forward rate of return.
Quite unattractive, although bear in mind I have not talked about share repurchases or dividend yields moving forward although some version is virtual certainty over the next 50 years).
But this is the simply the more pessimistic rates of 15% growth. What if growth averages in the middle around 20-30%?
The implied payback period comes up to betwee 24-28 years, or about 3-4% forward rates of return. Is this a reasonable rate of return by itself? No.
But is it reasonable if you include the options of potential future spin offs, share buybacks, yields all adding some form of percentages?
Is it reasonable when you consider 10% discount rates might be too high?
I think so. And there’s significant room for me to be wrong and still get the overall returns right.
Even if I’m wrong on drugs and autoparts and prime video and advertising, AMZN has the tenacity, engine of cash, ability, and information to try with other areas of growth.
There comes a point in time where corporations generate their own gravity wells - a place where talent, money, opportunities accrue simply because they’re best answered there.
These patterns are recurrent in nature and observable.
Go through the annals of great businesses and you’ll see what I mean.
Whether it was Jim Simons or Steve Jobs, Sam Walton or Jim Sinegal, Mark Leonard or Warren Buffett, like attracts like. I’m confident the company has the talent pools, abilities, and forward thinking to succeed.
I know they have the cash and opportunities to enter or create new markets.
What do you do when you figure all of this out?
I believed buying shares was the only choice left.
How much is $AMZN objectively worth?
Unlike what Pat Dorsey describes, I can’t put a number on it.
There’s a price at which I’m willing to sell it of course. But it would be a monstrous, ludicrous price verging on bubbly.
All I know is, given what can happen, given how hard Amazon is to kill, the markets it still has left to move in, the resources and talent pool it has, it’s hard to not find Amazon attractive at under $3k a share.
Disclosure: the author owns shares of Amazon. This is not investment advise. Do your own work. Good luck. Have fun.