There are questions that make us smarter and there are questions that make us obtuse by forcing our thoughts on the wrong track. The headline question is on everybody's mind, but probably it doesn't help us to go anywhere. It is first-level thinking and leaves the problem exactly where it is: a rather animated discussion, based on adventurous projections which have been extrapolated out of past results, as well as on common places regarding the power of scale, the disruptive power of the Internet, the death of traditional retailers, Amazon (AMZN) being "new economy," Wal-Mart (WMT) being "old economy" etc., etc.
The difference between first- and second-level thinking is explained by famous investor Howard Marks in his book "The Most Important Thing: Uncommon Sense for the Thoughtful Investor":
First-level thinking says, "It's a good company, let's buy the stock." Second-level thinking says, "It's a good company, but everyone thinks it's a great company, and it's not. So the stock's overrated and overpriced; let's sell.
So why is the headline question first-level thinking? - Because it seems to ignore a few facts:
A) It is not necessary to be the winner in order to be a good investment.
B) A company could be the winner, but still be a terrible investment.
C) This is no football game. Maybe neither of both will win, competition will continue, other companies will enter the arena, dynamics will change.
Here are the consequences of these considerations:
1) Probably (as investors) we don't really need to answer the headline question.
2) We should rather think about possible competitive dynamics that could rearrange the playing field all together.
3) We should focus on what we know. We should not base our decisions on fantasies about things we can't know for sure.
#2 is terribly complicated, which is probably the reason why everybody prefers to continue with the lazy "football game" interpretation of the problem.
#3 brings us to another myth: Even most of those investors that totally ignore #2, believe that investing in a business requires to make projections about its future. (I hear an uproar.) Well, in my opinion it does not.
At one of Berkshire Hathaway's (BRK.A) (BRK.B) annual meetings, Warren Buffett and Charlie Munger explained their ideal investment to be like shooting fish in a barrel, but after the barrel has been drained and the fish have quit flopping. And in a famous video, Alice Schroeder explains that Buffett does not make projections. (If you want to dig deeper, here is a good article on the subject by fellow Seeking Alpha contributor Todd Kenyon.)
Before we solve the enigma, let's think about Amazon: How can this stock be an investment as easy and guaranteed as "like shooting fish in a barrel, but after the barrel has been drained and the fish have quit flopping"?
Here are a few facts about Amazon:
- It is the Internet retailer with the largest operations worldwide.
- It does not make profits.
- It enjoys a favorable tax treatment that likely won't last forever.
- It can compete almost only on price.
- For many years, it has vacuumed up sales from traditional retailers, forcing them to close or to transfer their shops on the Amazon platform (paying fees).
- Many see a potential monopoly in Amazon. Regulators probably won't allow it at long last (if competition alone does not manage to make a dent).
Amazon certainly is an exciting story and has a huge potential. However, as an investment this is a swimming, very lively fish. There are lots of things moving. Any assumption related to future profits must be based on projections about the future trajectory of the business, its competitors, and its technological framework. Maybe I'm not smart enough, maybe I don't understand how to make a stone-dead fish out of this situation.
As far as Wal-Mart is concerned, here are some basic facts:
- It's the traditional retailer with the largest operations worldwide (with almost 7 times Amazon's sales).
- It enjoys one of the highest profit margins in the industry.
- It has a physical store network second to none and can compete on price, service and proximity to its customers.
- Wal-Mart certainly has a shot in online competition.
- As I have exhaustively explained in a series of articles (Reading Between The Lines Of Wal-Mart's Accounts - Part I - Part II - Part III), Wal-Mart does not need to grow in order to provide decent returns to its investors.
Maybe you start seeing a fish in an empty barrel?
However, I hear the objections: Amazon and Wal-Mart are certainly two very different stocks with a very different set of investors. The former are looking for growth and a quickly rising stock price, the latter prefer the proven, slowly growing steadiness of a dividend stock, which they deem to be perfect for income or retirement. Hence, instead of an answer to our headline question, I will formulate a different question, which in my opinion is more useful for investors:
Will Wal-Mart and Amazon live up to their investors' expectations at current prices?
In the case of Wal-Mart, in my opinion there is a strong probability that investors will not be disappointed; in the case of Amazon I'm not so sure. And being a retiree I'd rather go for the sure things.