When you saw the title of this piece, you may have thought, "click bait… he can't be serious, right?" That's probably what I would have thought… regarding every other stock except for this one. I assure you, I'm 100% serious when saying that Amazon (NASDAQ:AMZN) deserves a spot in every portfolio. And I do mean every portfolio (or at least, every portfolio with equity exposure). The more and more that I think about the markets and about the future, the more and more bullish I become on Amazon shares. In this piece I'll explain why.
Amazon: The Most Disruptive Force In Today's Market
I recently came across a CNBC article outlining Amazon's move into Australia and Gerry Harvey's, CEO of Australian retailer, Harvey Norman, response, "Amazon is the worst possible corporate citizen to have in our midst. There's no retailer in the world, practically, that likes Amazon." I suppose if I was a retailer in a market that Amazon was entering, I'd be upset about it too. Harvey continued saying that "Amazon is a marauder" and it "sent lots of businesses broke."
I can't disagree with Mr. Harvey on the first bit above, though the second bit is surely true. Amazon has certainly put a hurting on traditional retail. However, I think AMZN is being treated a bit unfairly by those who believe it's become an evil empire, it's definitely not the first retail company to revolutionize its operations and disrupt the traditional market. It was Wal-Mart (NYSE:WMT) who was known as the wrecker before Amazon came alone, putting the local mom and pop shops out of business with its lower prices. What we're seeing now with Amazon is nothing new; throughout history, innovation has inspired numerous stampedes that trampled over lessor business models as time moves on. I don't blame Wal-Mart or Amazon or anyone else doing this, for that matter. The marketplace is a competitive one and I expect businesses to compete to win.
Harvey said that Amazon is the worst corporate citizen. I don't exactly know what this means. Sure, it's nice to think about a world were everyone plays nice and has fun and goes home with a trophy at the end of the day. However, that's simply not how competition works. There's always a winner and always a loser. That's great. That's the very essence of competition. Hopefully those who're taking losses in the present will learn a lesson or two, become leaner and meaner, enabling them to re-enter the arena, take back some market share, and rekindle the cycle again and again.
I haven't read Adam Smith. I haven't closely studied capitalism enough to be any sort of authority on the subject. My basic understanding of modern capitalism is that it's a system where a governing body creates a general set of rules of which to play by (i.e. anti-monopolistic regulations and/or consumer protections) and afterwards the participants are left to their own devices when figuring out the best solutions to problems as ways and means to meet consumer demand; and, most importantly, it's the participants that own their ideas, allowing them to pursue profits, which theoretically serves as the fuel that spins the wheel.
I know, I know, it's basically impossible to describe such a complex system like this in a sentence (even one that runs on). Please, feel free to critique my definition, or better yet, attempt to describe capitalism in 90 words (I'll be generous and give you words, not characters) or less. But, this isn't a piece about free markets or economic systems; it's about Amazon and why I believe that just about every investor interested in the equity exposure, regardless of strategy or outlook or portfolio composition, should own shares of this terrible, horrible, no good, very bad corporate citizen.
The biggest hang up that I hear when it comes to investors, especially conservative ones, considering an investment in Amazon is the company's valuation. Simply put, it's very difficult to wrap one's head around it. I don't deny that the company seems grossly overvalued by many traditional valuation metrics. That said, I'm not sure if we've ever seen a company like this one; a company that doesn't settle for industry/sector boundaries, but instead casts nets far and wide, attempting to take market share in just about any area where it sees future growth. Amazon is considered to be a retail play with a significant and growing cloud component. However, the way I see it, Amazon is much, much more than this; its become a behemoth analogous to the Blob.
AMZN currently trades for 174x TTM GAAP earnings. I know, I know, that's enough in itself to make certain investors get sick to their stomachs. However, when looking at a company like this, you have to factor in growth (because the growth potential AMZN offers is essentially unrivaled in today's market). Looking forward two years to 2018 earnings expectations, we see that AMZN's forward P/E ratio shrinks to 68x. That's still a lot, I know; however, I don't see growth slowing anytime soon and I believe the company will grow into its current valuation over time. AMZN trades at a massive premium to the market, though I think it's a fair premium due to the fact that no other company (that I know of, at least) provides shareholders with such a long runway of likely double-digit growth.
No matter how bullish I am on AMZN shares, it's going to be nearly impossible for me to make an argument for owning the stock using traditional P/E and/or enterprise value/EBITDA. The numbers simply aren't there yet. However, revenues have been growing at ~20% for four years now and while that is surely to slow at some point; I expect to see strong, double-digit top line growth for years and years to come as this company continues to take market share, grow its ecosystem with new product/service offerings, and ride the secular waves, like rising e-Commerce trends or cloud adoption, that it hitched its wagon to years ago.
Gross margin has been rising nicely for years now as well, and I expect for that to continue. Amazon has become a cash flow machine, generating $14.6b in the trailing twelve months (this is up from just $3.9b for the full year in 2011). The company has made a habit of reinvesting these cash flows back into the business in pursuit of growth, though one has to assume that eventually Bezos will become content with his operations and the business will mature…or, he won't and it will continue to grow leaps and bounds due to the cash flows its best in class products and services are generating. I know many investors would like to see AMZN focus more on profits and even potentially returning cash to shareholders, though the way I see it, these are concerns that ought to come way down the road, not while the company is growing so rapidly. Who's really complaining about this growth anyway, besides Gerry Harvey?
Amazon's market cap is $406b. When companies become this large, investors begin to doubt further growth due to the "law of large numbers." I'm not sure how much I believe in this theory in the first place, hence the quotes, but I especially doubt its relevance to Amazon due to the company's unique, cross sector/industry operations & ambitions.
Buffett & Bezos
Warren Buffett did his annual interview with Becky Quick on CNBC's Squawk Box a few weeks back. I didn't watch it live. Instead, I recorded it, hoping to watch it with my wife (she enjoyed the "Becoming Warren Buffett" documentary on HBO, so I thought she may want to hear more from the man), but she's been busy with school, so I watched it the other night on my own. I had already been mulling this piece around in my mind, so although it was pretty late at night when the topic of Amazon and CEO Jeff Bezos came up, my ears perked up a bit. I knew that when writing a piece attempting to justify owning shares of AMZN in all portfolios (including the most conservative), having Buffett's backing would be a major boon. Granted, while Mr. Buffett, who manages a fairly conservative equity portfolio at Berkshire, doesn't own shares of AMZN, his kind words regarding Mr. Bezos and his marked regret when it comes to missing the AMZN boat play into my thesis.
Here's the full transcript of the Buffett/Squawk Box interview; it's worth a read when you have some time.
Here's a couple of questions that I sourced from the transcript regarding AMZN and Bezos specifically:
"BECKY QUICK: A major investor I spoke with recently asked me this question. And I'm not sure if it was supposed to be on the record or not, so I won't use the name. But this investor said that he or she had heard you recently making some comments about Amazon, where you were very-- complimentary of Amazon, its founder, Jeff Bezos, said he's probably the best manager you've ever seen.
WARREN BUFFETT: I-- think maybe he is, yeah. You know, I've said that. I mean-- it's remarkable. I mean, here, a guy -- you know,- gets in a car with his wife leaves-- leaves Shaw and starts driving across and he thinks, "How am I gonna take over the world? maybe I'll sell books online." It's he is one terrific businessperson.
BECKY QUICK: That investor then asked me, "Why don't you own shares of Amazon?"
WARREN BUFFETT: Well, that's a good question. And-- but I don't have a good answer. Obviously, I should've bought it-- long ago because I admired it long ago, but I didn't understand the power of the model-- as I went along. And the price always seemed to more than reflect the power of the model at that time. So it's-- one I missed big time.
BECKY QUICK: Is it too late or you just don't know?
WARREN BUFFETT: I just don't know."
After hearing this initially, I was pleased to see that I was in the same boat as the Oracle when it came to Amazon. Before taking the plunge and buying shares (my logic is described in more detail in this piece focused on the purchase last December) I too didn't "have a good reason" as to why I didn't own shares. I "admired" the business and had for some time, but I simply watched and watched from the sidelines as AMZN and Bezos continued to enter new markets and grab share, pushing the stock price ever higher. Simply put, eventually I went a step further than Buffett, deciding that the opportunity cost of not holding shares outweighed the valuation risks and I used a bit of weakness late last year to begin building a position.
So, Why Am I So Bullish On Amazon?
So much of my bullish thesis on AMZN boils down to Bezos. Like Buffett, I think he's a great manager… and probably an even better salesman. I doubt there's ever been a company in the history of the stock market that has been given more leeway by shareholders in terms of putting profits on the back burner in pursuit of growth. If it wasn't for the market's faith in Bezos' vision for his company, I imagine this ship might have sunk years ago with investor patience waning before economies of scale really began to kick in. Building broad ecosystems takes time, though once they've been constructed and the consumer becomes entrenched within, they become very wide moats that tend to lead towards massive profits (due to increasing margins via pricing power). I think Amazon is well on its way to building one of, if not the most powerful consumer facing ecosystems that we've ever seen. It is very difficult to build these systems, though once they're in place, I believe they're nearly equally as difficult to destroy. Peter Lynch once said that one should, "invest in businesses that any idiot could run because someday one will." I think that the empire that Bezos is building will have a moat so wide that any idiot could defend it.
Another of the most common used quotes in the business doesn't belong to an investing icon like Lynch, but instead hockey star, Wayne Gretzky. He said, "skate to where the puck is going to be, not where it has been." Sticking with the sports theme, Alabama football coach, Nick Saban believes that complacency is the enemy of excellence. The way to beat complacent competition is to follow Gretzky's advice. Bezos has proven to be a visionary in terms of getting out in front of secular trends (some might even say that he created them himself).
I think the best example of this "skating to where the puck is going to be" with regard to Amazon is the current e-Commerce trend that we're witnessing. I recently came across this Business Insider piece talking about the future of retail and the expected growth of e-Commerce. Here's a graphic from the piece, showing recent online sales history.
Source: BI Intelligence
As great as this seems, market penetration remains slight, which is why BI Intelligence projects that U.S. consumers will nearly double their online spending over the next 3-4 years with online sales reaching $632b by 2020. This data only concerns U.S. market trends; e-Commerce growth isn't limited to the United States borders. In general, global e-Commerce penetration remains very low, and I expect for overall online sales to grow substantially for decades to come.
Even If You're Not A Believer, I Like Owning AMZN As A Hedge
And now we get to the crux of my argument for investors of all types holding Amazon shares in their portfolio; the way I see it, AMZN is a great hedge for the long-only equity portfolio. I don't short shares on principle (unlimited downside/margin requirements), and I don't have any desire to own bonds right now as a conservative store of wealth/contrarian play to stocks due to rising rates and what I believe will be a secular bear market for bonds moving forward. So, when thinking about hedging my portfolio I think about market share. One of the biggest threats that companies face is disruptive innovation that makes them obsolete. This disruption leads to a loss of market share. By owning AMZN, that is probably the world's broadest disrupter, I help maintain overall market share exposure levels.
What I mean is by owning shares of AMZN, I'm essentially hedging my bets in several major sectors/industries: consumer staples & discretionary via retail (especially big box brick and mortar), packaged goods, food, and consumer facing technology on both the hardware and software fronts; transportation, especially regarding the shipping and logistics industry; and in technology, regarding the aforementioned consumer tech, as well as the commercial markets via enterprise software and cloud services. What's more, as AMZN continues to move into new markets, this list will grow with time. For instance, I have exposure to CVS Health Corp. (NYSE:CVS) and Walgreens Boots Alliance (NASDAQ:WBA) in my portfolio, and I've seen speculation that AMZN may move into the PBM business. I could easily imagine AMZN making a move in the digital/mobile payment space, putting pressure on holdings on mine, Visa (NYSE:V) & MasterCard (NYSE:MA), or moving into the digital travel agency space, potentially taking away share from companies like Expedia (NASDAQ:EXPE).
Really, I think there are no bounds to Bezos' ambition, and I wouldn't be surprised to see Amazon move into any market that it viewed as being vulnerable to disruption. A decade or two ago, who would have thought that this once lowly book selling company would be so entrenched in so many markets today? I can't say for certain what the future holds for AMZN, though I do feel pretty confident in saying that this company will continue to increase its footprint both vertically and horizontally, bringing me back to the Blob comparison.
Here is a list of the companies that I own that I believe are at realistic risk to Amazon's disruptive nature, in some way, shape, or form, in the present; and, as I stated above, I wouldn't be surprised if this list were to grow in the future:
Apple (NASDAQ:AAPL), Berkshire Hathaway (NYSE:BRK.B), Comcast (NASDAQ:CMCSA), Cisco (NASDAQ:CSCO), CVS Health Corp., Disney (NYSE:DIS), Digital Realty (NYSE:DLR), Alphabet (NASDAQ:GOOGL), Home Depot (NYSE:HD), IBM (NYSE:IBM), Intel (NASDAQ:INTC), Kimberly Clark (NYSE:KMB), Kroger (NYSE:KR), L Brands (NYSE:LB), McCormick (NYSE:MKC), Microsoft (NASDAQ:MSFT), Nestle (OTCPK:NSRGY), J.M. Smucker (NYSE:SJM), AT&T (NYSE:T), Time Warner Inc (NYSE:TWX), Unilever (NYSE:UL), United Parcel Service (NYSE:UPS), Verizon (NYSE:VZ), Walgreen Boots Alliance, Whole Foods Market (WFM), W.P. Carey (NYSE:WPC), technology sector select SPDR (NYSEARCA:XLK)
As you can see, that's a pretty significant list. I think it's the least I can do to own a handful of AMZN shares, regardless of valuation issues, as a hedge against any continued market share loss (and therefore, likely revenue and/or profit losses) by those companies.
I expect that many of you will disagree with me on this one, but that's alright, I feel very confident in my thesis regarding AMZN and its place as a part of my financial future. I can't simply find a stock with better, likely, long-term growth. What's more, Amazon remains one of the biggest threats to many of my individual holdings. Amazon is entering into and disrupting so many areas of the market that I can't think of a better long hedge to so many of my equity positions at once. Because of this, I think it's easily worth the valuation risk to give myself exposure to AMZN shares. I expect that AMZN's share price will continue to be volatile until the valuation begins to normalize, which is why I've decided to spread out my pricing risk by moving into this name slowly, over time. With that said, I don't imagine that I'll regret any of my AMZN purchases in the present, 5, 10, 20, etc., years into the future.
Disclosure: I am/we are long AAPL, CVS, KMB, AMZN, GOOGL, MSFT, TWX, V, WPC, BRK.B, DIS, HD, KR, NSRGY, UL, WBA, XLK, CMCSA, DLR, IBM, LB, SJM, UPS, WFM, CSCO, EXPE, INTC, MKC, T, V, MA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.