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Amazon: Is this compounder on sale?

Opdateret: 30. okt.

I like compounders, and I appreciate it when the CEO specifically mentions compounding, as he did in his first letter to shareholders. In that letter, he wrote, "Time is your friend when you are compounding gains. Amazon is a large company with some significant businesses, but we are still in the early stages of our development." Amazon has experienced significant growth, and if you had invested $100 in Amazon in 2000, it would now be worth $2.740 even after accounting for a 90% loss in the share price during the dotcom bubble. In this analysis, I will investigate if now is the time to buy Amazon.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that I do not own any shares in Amazon at the time of writing this analysis. I do own shares in some of their competitors, such as Microsoft, and Alibaba is my largest position. If you would like to copy or view my portfolio, you can find instructions on how to do so here. Like most other consumers, I have frequently made purchases on Amazon, and I have consistently had positiveexperiences with the company. I also really like Amazon Smile, where I can support one of my favorite charitable organization. (please donate if you can). Nevertheless, as always, I will keep this analysis unbiased. If you want to purchase shares or fractional shares of Amazon, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started.

Amazon is a multinational technology company based in Seattle. It primarily focuses on e-commerce, cloud computing, digital streaming, and advertising. They also manufacture electronic devices such as the Kindle, Fire tablet, Fire TV, Echo, and Ring. In addition, they also offer a subscription service called Amazon Prime. Meaning that Amazon is involved in all kinds of different businesses. Amazon has categorized all of its businesses into three segments: North America (61% of net sales), International (23% of net sales), and Amazon Web Services (16% of net sales). I believe that Amazon has a strong brand moat, as it consistently ranks among the top three most well-known brands in the world, and consumers trust the company.

Their CEO is Andy Jassy. He became the CEO in July 2021 and took over from founder Jeff Bezos. Andy Jassy joined Amazon in 1997 and has held various leadership roles before becoming CEO. Most notably, he founded and led Amazon Web Services (AWS) from its inception in 2016 until he became the CEO. He has an BA from Harvard University and an MBA from Harvard Business School. When growing up, he was a competitive tennis player, which has taught him a lot of lessons that he uses as a leader. He explained in an interview, "Tennis taught me what happens when you really work on something, and what happens when you don't." "You either win or lose based on how you perform in the moment." It translated into his first memo to employees, where he stressed the importance of moving quickly, getting things done, and working hard to solve customers' problems. Hence, it is safe to say that Andy Jassy expects a lot from his employees.However, he still managed to land in the top 25% of CEOs compared to similar-sized companies in employee ratings on Comparably. I don't believe we have much data to judge Andy Jassy as a CEO, but his work with AWS has certainly been impressive. I also appreciate how he emphasizes the importance of compounding in his letter to shareholders, as mentioned earlier.

I believe that Amazon has a strong brand moat. The new CEO is still new, but has delivered great results in other positions. Hence, I feel confident in his management abilities as well. Now let us investigate the numbers to see if Amazon does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.

The first number we will look into is the return on invested capital, also known as ROIC. We want to see 10 years of history, and we want the numbers to be above 10% in all years. I was quite surprised to see that Amazon has only delivered a return on invested capital (ROIC) above 10% in 3 out of the last 10 years. On a positive note, it is nice to see that Amazon seems to have delivered an acceptable ROIC from 2018 onwards, except for a very challenging 2022, which left a lot to be desired. ROIC isn't everything when investing, but I find the numbers a bit worrisome and something I would monitor moving forward if I were to invest in Amazon.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. This is much more reassuring, as Amazon has rapidly grown their equity over the last 10 years. It is certainly reassuring to see numbers like these, especially when compared to the underwhelming ROIC. It aligns with what Andy Jassy mentioned in his letters to shareholders when he wrote that it is still the early stages for many of the businesses that Amazon is involved in.

Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Free cash flow looked good up until 2021, as it has been positive every year and has shown a consistent increase year over year in most cases. However, it is disappointing to see that the free cash flow has been negative in the last two years. Andy Jassy mentioned why we have seen a negative free cash flow in 2021, which can be attributed to their consumer revenue surpassing all growth expectations during the pandemic. This was due to experiencing three years' worth of projected growth in just 15 months. While it is undoubtedly a great thing, it also created some short-term challenges that had an impact on free cash flow. Quoted from the letter to shareholders: "We spent Amazon's first 25 years building a very large fulfillment network, and we had to double that in the last few months to meet customer demands."Hence, we should hopefully see positive free cash flow in the long term.

Another important aspect to investigate is the level of debt, specifically whether a business has a manageable debt that can be paid off within a period of 3 years. We do this by dividing the total long-term debt by earnings. Doing the calculation on Amazon, I can see that Amazon has 1,46 years' worth of earnings in debt. It is within the acceptable range, and I don't see debt being an issue when investing in Amazon.

Like with all other investments, there are also some risks if you decide to invest in Amazon. Macroeconomics. Different macroeconomic factors could hurt Amazon both short-term and long-term. Management mentioned that things such highinflation, increased interest rates, global supply chain constrains, and the global economy downswing have directly andindirectly impacted their results. One example is that it increased operating costs due to higher utility costs, increased transportation costs, and higher wage rates. While recessionary fears have impacted customer demand. Management alsoexpects that macroeconomic factors will result in short-term headwinds for AWS, as companies are more cautious in spending. Regulations. Amazon will be the target of anti-trust/anti-monopoly regulations. One example is the American Innovation and Choice Online Act. If the bill gets passed, it will prohibit dominant tech platforms like Amazon from providingpreferential treatment to their own services in the marketplaces they operate. The bill has only just been introduced, and it is uncertain whether it will pass both chambers. We might see more regulations in the future, in addition to this bill.Martin Lau, the president of Tencent, has previously stated that the internet regulations witnessed in China are likely to occur in other regions of the world as well. Furthermore, the Chairperson of the Federal Trade Commission is Lina Khan,and it is no secret that she is a strong proponent for more regulations, as evidenced in her book titled "Amazon's Antitrust Paradox". Competition. In its annual report, Amazon mentioned that it faces intense competition. Amazon is facing competition in all of its segments from some great companies. When your competitors include companies such as Google, Microsoft, and Alibaba, competition will always be a risk factor. Hence, I believe it is a risk factor that one needs to monitor moving forward, especially their AWS business, as it is a high-margin business for Amazon.

There is also plenty of potential for Amazon moving forward. Amazon Web Services (AWS). AWS contributes to 14% of Amazon's revenue and has been the fastest-growing segment since 2016. It is expected to continue being the fastest-growing segment in the future. It is interesting that the operating margin of AWS in 2022 (29,4%) is much higher than the operating margins of the other segments, North America (3,8%) and International (0,8%). AWS has a global market share of 34%, making it the largest cloud services business in the world. The global cloud infrastructure market is expected to grow at an 11,8% CAGR until 2030. Hence, Amazon Web Services is a high-margin business that is expected to grow faster than the other segments in the future. This indicates that Amazon is likely to become more profitable moving forward. Digital Advertising. Most people might not know it, but Amazon has become the third-largest digital advertising company, trailing only behind Google and Facebook. This business is experiencing rapid growth. In 2022, the revenuereached approximately $39 billion, which was a 25% increase compared to the previous year. The global digital advertising market is expected to grow at a CAGR of 21,6 % over the next five years, and Amazon has the potential to grow even faster, as they currently only hold a 10% market share. Amazon hasn't mentioned the margins on their digital advertising business, but it is typically a high-margin business, which could enhance Amazon's profitability in the future. Amazon Prime. Loyalty programs are beneficial for businesses as they establish an emotional connection between customers and the business. Additionally, they provide valuable customer insights that can enhance personalized marketing efforts. Moreover, loyalty program members tend to spend more per purchase compared to regular customers.Prime members certainly spend more on Amazon than non-members. The average spending rate of Prime members is $1.400 a year compared to $600 a year for non-members. Amazon currently has around 200 million Prime members worldwide, with approximately 163 million in the United States. This indicates that the number of Prime members has doubled since 2018. If Amazon can continue to increase the number of Prime members, it should result in greaterprofitability in the future.

All right, we have gone through the numbers, potential and risk regarding Amazon, and now it is time for us to calculate a price for Amazon. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS of 2,80. It is slightly lower than the EPS of 3,24 in 2021 but higher than the EPS of 2,07 in 2020. In 2022, EPS was negative. I have chosen an estimated future EPS growth rate of 15% (which is the highest possible growth rate I use), an estimated future PE of 30 (which is double the growth rate, as the historical PE for Amazon has been higher), and a minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $84. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Amazon at a price of $42 (or lower, obviously) if we use the Margin of Safety price.

Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 46.752. The capital expenditures were 63.645. I tried to look through their annualreport to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 44.551,5 in our further calculations. The tax provision was -3.217. We have 10.242 outstanding shares. However, it is not possible to make the calculation as Amazon has more expenses than income.

The last calculation is the Payback Time. I also described in "MY STRATEGY". However, it is not possible to make this calculation with a negative free cash flow.

I believe Amazon is an interesting company, and while we have a new CEO, I feel comfortable with the management as well. I found some interesting things while researching Amazon. I'm very underwhelmed with the return on invested capital (ROIC) that Amazon has produced, even though it has improved in recent years. I believe that Amazon will face some short-term headwinds due to macroeconomic factors, as mentioned in the analysis. However, I like that Amazon is focused on growing their high-margin businesses, which should lead to higher profitability moving forward. Nonetheless, I personally feel that there are better companies out there to invest in now. If Amazon continues to grow their cloud and ad businesses, I might change my mind moving forward. I don't expect that Amazon will fall to my margin of safety price of at $42, but if it does, I might consider opening a small position because the risk/reward ratio would be favorable.

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