Amazon: Please Drop to $85

I have been trying to buy Amazon (AMZN) for five years now, but because I only buy companies that have a price to free cash flow of 15 or less, I was hoping they were going to miss and allow me to finally get in, but alas they blew away the quarter and I am going to have to wait again. With their increase in TTM Free Cash Flow to $1.92 Billion, my buy price has now moved up to $63.85.

I am so impressed with their results that I will probably have to up my purchase rule and add some more risk by bumping my buy price to 20 times free cash flow and look for an entry point of $85 a share. My sell criteria is 30 times free cash flow or $127.50, so if I ever get lucky enough to get in at $85, I will have a long way to go before I will need to sell.

People will probably say I am crazy and Amazon will not get back to $85 anytime soon, but they said the same thing about Coach (COH), which not only went down to 15 times free cash flow but then proceeded all the way down to 7.52 times. I learned a long time ago from observing Warren Buffett’s purchases that you have to set your price and wait (sometimes for a long time) until the stock hits that price. It took me seven years to buy Coach, but I got it.

Amazon has a Free Cash Flow Return on Invested Capital (FROIC) of 42%, which for those who don’t know what that means, it’s simply for every $1 of capital employed Amazon generates $42 cents in free cash flow. Those are amazing numbers as I like to usually buy companies with 20%+ FROIC. Its main bricks and mortar competitor Wal-Mart (WMT) for example has a FROIC of just 8 while having a Price to Free Cash Flow of 23. So for every $1 of Capital Amazon employees they return 525% more free cash flow than Wal-Mart. And as for Barnes and Noble (BKS), they are no threat as they have of FROIC of 8.25%.

There is only one game in town and that is Amazon, so please fall to $85 so I can get some of your stock.

Disclosure: Long COH, no positions in WMT, AMZN, BKS

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Mycroft Research, and should not be construed as personalized investment advice.

It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

Comments

[RK:]

Just curious, why didn't you buy Amazon at $40 when the market crashed. At that time, Google was going for $250, Apple at $80. In retrospect, those were golden opportunities.

Oct 23 07:33 PM

[Peter Mycro...:]

In 2008 Amazon had a free cash flow per share of $1.29. When you do my calculation of buying at 15 times free cash flow per share you get $1.29 X 15 = $19.35, so as you can see $40 was still twice what I was willing to pay.

Apple's FCF was $4.74 so $4.74 X 15 = $71.10

Google's FCF was $13.18 so $13.18 X 15 = $197.70

So as you can see I just missed them but I set my price and then wait for that price. I use the same punch card method as Buffett does, so when I get stuff at those levels I tend to hold them until they hit 30 times FCF. My clients have 29 stocks in their portfolios so I was able to find similar quality at my price. Had the Federal Government not bailed everyone out I would have had a similar situation to what Warren Buffett had in 1974 and cleaned everything up.

I have proved the 15 FCF rule in a 58 year backtest that I did. If you want to see it just go here;

mycroftresearch.com/up...

With results like those you can see why I am so stubborn in my price to FCF of 15. Another interesting point is that the average return for the backtest is very close to what Warren Buffett has achieved from 1958-2007.

Oct 23 11:07 PM

[RK:]

I respect you sticking to your model. However, perhaps your model will not bag you growth stocks except in a armageddon scenario. And perhaps you should be content as Mr. Buffet in not owning growth stocks.

As a side note, Mr. Buffet did buy BYD stock. Is that conforming to the FCF of 15 still? I am too lazy to find out the price that Mr. Buffet paid for BYD.

Oct 25 12:15 PM

[Peter Mycro...:]

Since I am a Fisher Analyst (Philip A. Fisher) I like to try and only invest in growth stocks that I can buy at a value price level. What you missed in my article is the FROIC. FROIC stands for Free Cash Flow Return on Invested Capital. I identify first, stocks that have a FROIC of 20%+ and only then do I go to Wall Street and look at what they are selling for on a FCF basis.

FROIC asks each company "How much FCF per share are you going to return for me on Main Street for every $1 of Total Capital that you employee.

I do my own research and don't invest in the same stocks as Buffett, because he does his own thing. What I admire about the man and have incorporated in my own strategy is to determine my price that I would like to pay and wait for each stock to hit that price. I have also taken emotion out of the picture and sell always at 30 times FCF per share.

Buffett is his own man and though I have tried for 30 years to pin him down and figure him out, he makes investments like BYD, which have some of the worst numbers that you can find. I am at a totally loss to figure out how he thinks, when he makes moves like that.

I do my own thing and let him do his own thing. My system works for me and I am sticking to it, because I understand it. Buffett made some lousy investments in stocks like Iron Mountain and Autonation, which I didn't understand why he made them, so I just moved on and decided to do my own thing.

If your interested in learning about Fisher, here is a summary from my website that will get you started;

mycroftresearch.com/Ou...

Disclosure : No positions in BYD, IRM, AN

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice.
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.


On Oct 25 12:15 PM RK wrote:

> I respect you sticking to your model. However, perhaps your model
> will not bag you growth stocks except in a armageddon scenario. And
> perhaps you should be content as Mr. Buffet in not owning growth
> stocks.
>
> As a side note, Mr. Buffet did buy BYD stock. Is that conforming
> to the FCF of 15 still? I am too lazy to find out the price that
> Mr. Buffet paid for BYD.

Oct 25 01:45 PM