Amazon: Is this compounder on sale?
Opdateret: 20. apr.
I like compounders and I like when the CEO specifically mentions compounding, as he did in his first letter to shareholders, where he wrote "time is your friend when you are compounding gains. Amazon is a big company with some large businesses, but it is still early days for us." Amazon has compounded and if you had invested $100 in Amazon in 2000 it would be worth $2.740 now and that is including a 90 % loss in the share price. 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 shares in Amazon at the time of writing this analysis. I do own shares in some of their competitors like Microsoft and Alibaba is my largest position. If you would like to copy or see my portfolio, you can see how to do so here. Like most other consumers, I have often bought things at Amazon, and I have only had good experiences 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.
Amazon is a multinational technology company that is based in Seattle, which primarily focuses on things like e-commerce, cloud computing, digital streaming, and ads. They also manufacture electronic devices like Kindle, Fire tablet, Fire TV, Echo, and Ring. In addition, they also offer a subscription service in Amazon Prime. Meaning that Amazon is involved all kind of different businesses. Amazon has grouped all their 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 usually ranks among top 3 in the world's most well-known brands and consumers trust the company.
Their CEO is Andy Jassy. He became the CEO in July 2021 as took over from founder Jeff Bezos. Andy Jassy joined Amazon in 1997 and has held various leadership roles in Amazon before becoming CEO. Most notable is that founded and led Amazon Web Services (AWS) from its inception in 2016 until he became the CEO. He has an AB 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, which 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 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' problem. Hence, it is safe to say that Andy Jassy expects a lot from his employees. However, he still managed to land 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 on as a CEO but his work with AWS has certainly been impressing and I like hos he stresses the importance of compounding in his letter to shareholders as mentioned earlier.
I believe that Amazon has a brand moat. The new CEO is still new but has delivered great results in other positions. Hence, I feel confident in management 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 investment 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 ROIC above 10 % in 3 years within the last 10 years. On a positive note, it is nice to see that Amazon seems to have delivered an acceptable ROIC from 2018 and onwards, except for in a very challenging 2022, which left a lot to desire. ROIC isn't everything when investing but I find the numbers a bit worrisome, and something I would monitor moving forward, if I was to invest in Amazon.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. This is much more reassuring numbers as Amazon has grown their equity at a rapid pace ever over the last 10 years. It is certainly reassuring to see numbers like these compared to the underwhelming ROIC. It fits the bill of what Andy Jassy mentioned in his letters to shareholders, when he wrote that it is still early days for many of the businesses that Amazon is in.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Free cash flow looked good up to 2021, as it has been positive in all years and increasing year over year in most of the years. However, it is a bit disappointing to see free cash flow being negative in the last two years. Andy Jassy mentioned why we have seen in negative free cash flow in 2021, which comes down to their consumer revenue outperforming all growth expectations during the pandemic, as they had three years of forecasted growth in 15 months. While it is obviously a great thing, it also created some short-term challenges that took its toll 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 months to meet customer demands." Hence, we should hopefully see positive free cash flow within long.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation on Amazon, I can see that Amazon has 1,46 years 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 high inflation, increased interest rates, global supply chain constrains, and the global economy downswing have directly and indirectly impacted their results. One example is that it increased operating costs because of higher utility costs, higher transportation costs and increased wage rates. While recessionary fears have impacted customer demands. Management also expects that macroeconomic factors will result in short-term headwinds for AWS as companies are more cautious in spending. Regulations. Amazon will be the target in anti-trust / anti-monopoly regulations. One example is the The American Innovation and Choice Online Act. If the bill gets passed it will prohibit dominant tech platforms like Amazon from giving preferential treatment to their own services in marketplaces, they operate. The bill has only just been introduced and it isn't certain that it will pass both chambers. We might see more regulations in the future besides this bill. Martin Lau, president of Tencent, has previously stated that the internet regulations we have seen in China are something that will also happen in other parts of the world. Furthermore, the Chairperson of the Federal Trade Commission is Lina Kahn, and it is not secret that she is a large proponent for more regulations, which is evident in her book called "Amazon's Antitrust Paradox". Competition. In their annual report, Amazon mentioned that they face intense competition. Amazon is facing competition in all their segments from some great companies. When your competitors include companies like 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, and particularly their AWS business as it is a high margin business for Amazon.
There are 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 and expected to be the fastest growing segment moving forward. It is interesting because the operating margin of AWS (29,4 % in 2022) is much higher than the other segments North America (3,8 % in 2022) and International (0,8 % in 2022). AWS has a global market share of 34 %, which makes it the largest cloud services business in the world. The global cloud infrastructure market is expected to grow at a 11,8 % CAGR until 2030. Hence, Amazon Web Services is a high margin business that is expected to grow faster than the other segments moving forward, which means that Amazon should be more profitable moving forward. Digital advertising. Most people might now know it but Amazon has become the third-biggest digital advertising company behind Google and Facebook and this business is growing at a fast pace. In 2022 it reached approximately $39 billion in revenue, which was up 25 % compared to the year before. The global digital advertising market is expected to grow at a CAGR of 21,6 % over the next five years and Amazon has potential to grow even faster, as they only have a 10 % market share. Amazon hasn't mentioned the margins on their digital advertising business, but it is usually a high margin business, which could increase the profitability of Amazon moving forward. Amazon Prime. Loyalty programs are good for business as they build an emotional connection for the customers to the business, it delivers customer insights that can improve personalized marketing and loyalty members are more likely to spend more per purchase than regular customers. Prime members do 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 being in the United States, which means that the numbers of prime members has doubled since 2018. If Amazon can continue to grow the number of Prime members, it should lead to higher profitability moving forward.
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 a bit lower than 2021 of 3,24 but higher than 2020 of 2,07. In 2022 EPS was negative). I chose an Estimated future EPS growth rate of 15 (which is the highest possible growth rate I use), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Amazon has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $84, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Amazon at 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 was 63.645. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning 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, with a negative free cash flow, it is not possible to make this calculation.
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 when researching Amazon. I'm very underwhelmed with the ROIC that Amazon has produced, even though it has been better in the later years. I believe that Amazon will face some short-term headwinds due to the macroeconomic factors, which I 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 continue 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 at $42 but if it does, I might open a small position as the risk/reward will be worth it.
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