Amazon.com (AMZN) stock has been flying in the past couple of years, almost doubling its share price and recently touching an all-time record high.
The rise in the stock price has been driven by sustained growth in revenues, while profits have stayed close to break even. With a market capitalization of about $165 billion, it is today one of the largest companies on earth by market value and similarly ranks very highly on annual revenues.
With cash and short term investments of about $7.5 billion and total debt of about $3 billion, Amazon is in no danger of financial trauma. The issue regarding Amazon is simply one of valuation - is it worth the price the market has been willing to pay?
Those who are short the stock think it must ultimately fall since it is all but profitless despite the growing sales. The bulls subscribe to the thesis that Amazon is purposely pricing to deliver the most value possible to the consumer while generating enough cash flow to fund its growth without external financing, establishing Amazon as a "go to" location with a consumer franchise as strong as Wal-Mart (WMT) or Costco (COST), two companies that have similarly made "value to consumer" the central theme of their vast retail businesses.
Wal-Mart's growth was based on physical stores with a reputation for the lowest prices and during its early years typically in small towns rather than major centers. Wal-Mart invested heavily in logistics as it grew to ensure it could manage its vast inventory in thousands of retail locations and its worldwide purchasing system. As Wal-Mart became established its growth turned to international markets and today it has more outlets outside than inside the United States.
Costco's success is a business model where the bulk of its profits arise from subscriptions and the products are sold through to customers almost on a pass-through basis, making it very hard for others to meet a Costco price.
In my view, Amazon is aiming at Wal-Mart and Costco as its major competitors. To be successful against such retail giants, Amazon needs a compelling unique selling point. And it has one. Amazon offers what is often the lowest price and its products are not only available from your desktop or mobile device but also are delivered to your door in a relatively short time.
For many consumers, Amazon.com is the number one place to shop online. By the end of 2012, it had over 200 million customers.
What I observe is an approach to retail where Amazon wants first and foremost to establish itself as the pre-eminent retail brand online bar none. It wants to be top of mind, ahead of Wal-Mart and Best Buy and Staples and many other retailers with online sales. In that it is being successful, far outstripping its major online competitors.
With respect to the stock price, the $64 question is who is right - bulls or bears? While there is no doubt that the stock price will be vulnerable to any slowing of sales growth, I think the bulls may have this one right. At the 25% annual rate of growth Amazon currently displays, it will be a $120 billion company in 3 years and a $500 billion company in 9 years. That is a bit larger than Wal-Mart is today. Moreover, it is achieving that growth largely with internally generated funds despite heavy spending on its logistics and fulfillment infrastructure which, like in the case of Wal-Mart, is an essential component of its strategic emphasis on value and service.
The arithmetic for the bull case is relatively simple. If Amazon does become a $500 billion dollar company and can earn 5% net income to sales it would have 2022 earnings of $25 billion. At 14 times earnings its value in 2022 would be $350 billion. At an 8% discount rate its value today would be $175 billion. And it is, more or less.
I have no position in Amazon.