Amazon and Facebook were in the news this week for “joining an exclusive club open to only the richest companies in the world: both crossed the half-a-trillion mark.” Those two companies join Apple ($785 billion as of today), Alphabet/Google ($652 billion), and Microsoft ($564 billion) in the exclusive club of companies whose market capitalization tops $500 billion. To put the size of that market cap into perspective, consider that the entire Mexican stock exchange has a current market valuation of $438 billion, Thailand’s publicly traded stocks are worth $468 billion and the Russian stock exchange has a market cap of $554 billion! Together, the five US companies in the “$500 billion” club have a combined value of nearly $3 trillion… To put that into perspective, just those five US companies, as a separate country or stock exchange, would be the eight largest stock market in the world (see table above), and 40% larger than No. 9 Canada’s entire stock market and almost 50% (and $1 trillion) larger than the German stock exchange!
Some arithmetic:
Amazon just reported quarterly earnings of $200 million. At that rate, it would take 2500 quarters to earn $500 billion. That is 625. Years.
Call me impatient, but I do not care to wait 625 years to earn back my investment. I would rather see the money paid back a bit sooner. Like maybe 10 years.
If you want a $500 billion investment paid back in 10 years, then you need quarterly earnings of $12.5 billion. What does Amazon have to do to achieve that?
Their earnings are their sales times their profit margin. Investopedia writes,
Each year, the S&P 500 releases industry specific returns on equity and net margins, and each year the retail industry is among the least profitable. This is especially true for web-only retailers, which often see net margins as low as 2.50 to 3.50%.
So if we assume that Amazon is capable of achieving a 4 percent profit margin, we are being generous. At that profit margin, to get $12.5 billion in quarterly earnings, you would need $312.5 billion in sales. Actual sales last quarter were $38 billion.
Unless I have made some errors (check to see that I haven’t messed up by a factor of 10 somewhere), this arithmetic says that Amazon needs to be 8 times as big as it is, with a generous profit margin, in order to make me want to own the stock.
In July of 1999, I wrote Arithmetic in a Bubble. My first blog was an extended exploration of the topic. Maybe it is time for that blog to make a comeback.
$312.5 billion in sales a quarter would be $1,000 per American per quarter. That beats my household, and we do a ton of Amazon shopping. Even Walmart ‘only’ about $130 Billion in revenue per quarter.
Well, it’s worth noting that this was a significant drop-off in profits. The article I read said EPS for the same quarter in 2016 was 1.78 vs .40 for the current year. At a share price of $1,017, the last number I saw, it only takes 142 years to make back your investment with the 2016 EPS instead of 625. Not great, obviously, but still a liiitle bit more reasonable.
Of course the math really doesn’t add up and it never will. Eventually reality will set in, but we may be dead when it finally does.
I’m certainly not an Amazon apologist, and am not confident enough to own anything but index ETFs of various types, but context worth noting when considering projections of Amazon’s price vs. earnings:
AWS (the Amazon “cloud”), is wildly profitable (20%+ margins), and while only 10% of their revenue currently, is growing much (over 2x) faster than the rest of the business. Of course MS and Google are pushing hard on this business, and margins could come down.
Q2 2017 (semi-accurate at least)
AWS
Revenue 4,100M
Op Income 916M
Op Margin 22%
Est. Y/Y Growth ~50%
Amazon ex-AWS
Revenue 33,500M
Op Income -1544M
Op Margin -4%
Est. Y/Y Growth ~22%
The -4% on ex-AWS certainly suggests Amazon is still pouring cash into new initiatives (e.g. their India market entry is a big loser for them right now).
The piece you are missing is that Amazon is not a web only retailer. They are hardly a retailer at all. Half their profits come from web services, last I say from Feb they had 3 billion in profit on 12 billion revenue, and growing.
I think the valuation is crazy at this price, but you fundamentally misunderstand their business if you think they are a retailer at all. They are better understood as the retail infrastructure. They are developing tools so that other retailers can pay a factory to produce goods, then pay amazon to do everything else between receiving those goods to delivering them to the end user.
Eli Dourado said that reported profits are only so low because Amazon invests returns in new assets. He says you’d need to look at changes in assets to properly grasp their gains.
If you’re so certain, then short it. All these people who predict bubble are all talk. Market can remain irrational than solvent is the defualt repsonce to such a proposition . They are doubling gross income every 2.5 years.
Ahem, Trump is improving sentiment, so the multiple is increasing.
I think the comments with AWS hit the mark. If you think back to the 2000 crash, really a lot was going on. Internet went from being an odd luxury item to an everyday necessary item. So it was easy to lose track of the basic math and things like P/E ratios. Amazon is the same. Yes as a retailer they are vastly overpriced, but what if they become the leader in self driving cars as they have in cloud computing? On AI generally? Can they replace all brands? Again, rational minds may think these are long shots, but hope springs eternal, and the bulls have been right so far. But at some point Wall Street demands more. And Amazon is one, and not the most extreme, example (think Tesla).
The problem is I can see it. Investors have even more hands than economists.
I’m at the point I go out of my way to shop at Wal-Mart because I want to give Amazon less business. What does that say?
As others said, look at free cash flow, not profit. The free cash flow is, IIRC, a bit more than an order of magnitude larger than the earnings you report.
What if Ebay, Wal-Mart, Amazon, and Uber were to collude…with the Russians!
But seriously, under the Buffett standard of ability to invest large amounts of capital at high rates of return, the question is how close to taking over the world do you want to bet Amazon will get?
A lot of Amazon spending is what Arnold calls “investment in organizational capital” – that’s what created AWS and Kindle and Alexa and all the other businesses that first appeared on the income statement as expenses. So you have to back out all those “expenses” (really investments) in order to understand the real cash flow situation.
A good example of this argument can be found here.
https://seekingalpha.com/article/603331-making-sense-of-amazons-market-value
Didn’t Dean Baker write something similar on Amazon? And WTF is all that VC dumped into Uber these days? They still lose $3B in 2016 and throw money on every single problem. And they appear to be hurting local Taxis but not killing them. So these dreams of monopoly like Uber still seems really off.
Well, since 1994, Wall Street loves nothing more than new shiny Tech companies that are going to change the world. And some like Google or Facebook end up doing that. And the weirdest part of tech is how quickly these .1% of these companies go from beginning to near monopoly/oligopoly status in 5 to 10 years with endless cash reserves. So investors over trust Amazon to take over Groceries and retail markets or dump billions into Uber that will have some near monopoly status really soon. But there are others that question this logic.