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Valuing Amazon

Dec. 26, 2017 2:51 AM ETAmazon.com, Inc. (AMZN)75 Comments
Billy Duberstein profile picture
Billy Duberstein


  • David Einhorn is wrong. Amazon does not defy laws of value investing.
  • In fact, Amazon is the only FANG stock in the opportunity portfolio.
  • After a big 2017 run, the stock seems fairly valued now under my assumptions which I think are more than reasonable and may prove conservative.

David Einhorn, an investor whom I respect, recently talked about Amazon (NASDAQ:AMZN) and Tesla (TSLA) as "defying the laws of value investing," putting each into his “bubble basket.” While I may agree about Tesla (although I admittedly haven’t done nearly the amount of work on it to have a judgment), I think he’s dead wrong about Amazon - and as I wrote about before, Netflix (NFLX), for that matter (also in his "bubble basket").

Amazon, however, is a part of my opportunity strategy’s portfolio - in fact, this year it was the only FANG stock in it (unfortunately). I happen to think Einhorn is dead wrong about Amazon, and Bill Miller, who is a big Amazon bull, is more correct.

Amazon is in the portfolio because: a) its total addressable markets (ecommerce, cloud computing, and streaming video) are far bigger than those of the other FANG stocks. Moreover, Amazon seems to have a policy of spending all of its profits on experimental research and development, as well as new data centers for AWS and fulfillment centers for speedier Prime delivery. Therefore, the company spends all it can on future growth and to further cement its deep competitive advantages, which makes valuing Amazon trickier than simply taking a multiple of GAAP net earnings.

Earlier this year, I attempted to value Amazon using a discounted cash flow analysis, and found it undervalued. After a 40% gain and recent blockbuster earnings, I revalued the company. And while there are obviously a lot of assumptions that go into it, it is better to get things approximately right than precisely wrong. So let’s dig in.

Capitalizing Research and Leases

One of the first things that I did was capitalize both leases as well as research & development. Amazon is, of course, in large part a tech company, and often a tech

This idea was discussed in more depth with members of my private investing community, "The Fat Pitch Expedition.' on Nov. 5

This article was written by

Billy Duberstein profile picture
I am a California-based financial advisor and run a concentrated, long-biased equity strategy. NYU Stern MBA, former student of Damodaran and Galloway, among others. A love of the dramatic arts/narrrative, sports, and music all inform my investing philosophy. I have written and appeared on several investment publications such as The Motley Fool, Barrons, and Cheddar TV. My tastes run the gamut of investing approaches (value, GARP, and high-growth disruptors) that I like to characterize as "Special Companies" and "Special Situations" -- any unique bottoms-up opportunity that has  outsized risk/reward characteristics.

Analyst’s Disclosure: I am/we are long AMZN, NFLX. 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.

Amazon is in the Opportunity portfolio, whereas I own both Amazon and Netflix personally. Netflix is currently on my watchlist, which I also update every month or so on the Fat Pitch Expedition.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (75)

What about the time value of money invested today (research & development) yielding EBIT only in the future? Adjusting today's EBIT by reducing today's costs for future EBIT increases ignores the time value of money. Its another thing that the tax shield and that Amazon will probably increase intrinsic value over time will possibly compensate for this.

But a much higher margin of safety must be demanded than currently allowed for.
Billy Duberstein profile picture
No, because the R&D costs become part of the reinvestment costs (so free cash flow is the same). Capitalizing these costs merely give a roadap to true profitability in later years.
What I find most interesting of all regarding Amazon is the debate about its valuation. If one is a Amazon bull based on momentum, technicals, and over all market strength, then thats fine . Where it gets really surreal is where we have Amazon bulls that actually attempt to justify and rationalize the share price. To me this in itself is the hallmark sign of how big of a bubble the stock really is. At first some jump in , just hoping to ride the wave . After so long of a rise, those same people actually begin to believe that the underlying fundamentals are strong. Great to be riding the wave, but those that really believe will be crushed to death under the white foam of the crash
Gary J is Rich on AMZN profile picture
"Great to be riding the wave, but those that really believe will be crushed to death under the white foam of the crash"

Hey do us a favor and let us know when. Meanwhile you got the "Great to be riding the wave" part right. Very right.
Currently AMZN overstates operating cash flow because of its use of capital leases.This increase in operating cash flow in turn results in overstating free cash flow As of DEC,15 2018,all companies will be required to bring all leases onto their balances sheets;consequently AMZN will no longer be able to overstate their operating and free cash flow in this manner
The fact that you could come to the conclusion that AMZN was ONLY fairly priced even with some extremely liberal assumptions ,is testimony to the lengths that some will go to justify a super overpriced stock.
The only large capitalization companies that compare to AMZN are NFLX,which will never be cash flow positive and TSLA which is does not have a clue on how to produce cars in significant numbers
AMZN will not be insolvent due to its AWS,but both TSLA and NFLX will be .
Robert Honeywill profile picture
"Having said that, Bitcoin is a significantly safer investment than Amazon."
Did you mean "surer", i.e., sure to lose your money in both, but surer to lose your money in Bitcoin :)
Gary J is Rich on AMZN profile picture
I find cashing out some AMZN every time it doubles and still having plenty about as safe as it gets. Besides I got rich taking risk not looking for "safe".
And there it is folks. Gary J just revealed to you how it should work. Buy a lot of great stock cheap and live happily of the proceeds of selling it occasionally to support your lifstyle. Thanks Gary. If only they would listen.
Gary J is Rich on AMZN profile picture
By George I think you've got it! Set for life in fact.
Short Prince 7 profile picture
I'm sorry but who are you exactly compared to David Einhorn?
the big questions and most important for me is can bezos get amazon ROC to 20% because if he can amzn will be making lots of people more money if not i think they are in trouble.
hard to bet against him. id say its 60/40 in his favor

btw love wal-mart. jet.com great purchase. hope it gets cheap
Michu profile picture
I don´t know where Amazon stocks are going. But I think the alternatives are better. An example would be Best Buy (I am not invested), which is in a similar business and much cheaper. It shows the same price momentum (+52% in 1 year). So why buy Amazon stocks?
Gary J is Rich on AMZN profile picture
I bought it to make a tremendous amount of money. Which I still do.
Michu profile picture
The fact that Amazon is so highly valued and the share price has risen steadily does not mean that the company is actually so valuable.
Bitcoins have an intrinsic value of zero, but they have increased by 117000% in the last 5 years. In comparison, even Amazon is a lame duck. However, the prices can go back at any time. This is only the sentiment of the investors which can push the price to irrational heights.
Gary J is Rich on AMZN profile picture
"However, the prices can go back at any time.

thanks, didn't know that.
"Amazon seems to have a policy of spending all of its profits on experimental research and development, as well as new data centers for AWS and fulfillment centers for speedier Prime delivery."
Very little real profits for a company of it's size. I love to buy from AMZN when the price is good but, it is only about 10 % of the time. WMT SC Bestbuy Monoprice NewEgg Lowes and many others beat them on price all the time. Just purchased a 227 piece tool set from Lowes for $89.10, with free shipping, at my house in 3 days. Best price from Prime $130, 32% savings.
Also, purchased a Whirlpool refrigerator from Lowes in Oct for $559 with my 10% military discount. Reg price $849. Amzn price $1012.50, even higher than the MSRP of $949.
AMZN price fail big time.
The smart money will exit AMZN and take their profits and people waiting for Amzn stock price to reach $2,000 will be holding the bag of losses.
Gary J is Rich on AMZN profile picture
I buy on Amazon because the price is better 90% of the time.
Proof - I show purchases all the time that beat AMZN, you just say 90% every time you reply. Following Jeff's lead are we.
Gary J is Rich on AMZN profile picture
Oh and forgot I get another 5% off with Chase Amazon Visa card. Make that about 95% of the time. Prices over about 10k I check. Time, convenience, 1-click and on doorstep, etc. > money for me.
DavidS 31 profile picture
Thanks for the article. You have done some good research. I make 2 comments;

1. 25% rev CAGR for 5 years is way....way, too optimistic.

2. For cloud computing, Amazon was first mover but it now is not dominant. Microsoft is clearly winning, so i suggest be careful there with your assumptions there.
Gary J is Rich on AMZN profile picture
Correction - totally dominant

"Amazon.com Inc. unveiled new machine-learning tools, including algorithms that automate decisions and speech recognition, seeking to solidify its DOMINANT position over Microsoft Corp. and Alphabet Inc. in the fast-growing and profitable cloud-computing market."
DavidS 31 profile picture
Your opinion is noted :)

Maybe we actually agree;

Amazon is dominating machine learning/AI/algo's/speech recognition/and stuff.....

Microsoft is dominating customers/sales/market share......
Gary J is Rich on AMZN profile picture
Yes the Word/Excel users love it!
rnn profile picture
Too much analysis is bad for the brain, just let it go. More thinking more charts, more software doesn't add up to more profits.
In addition to what I wrote before, here are two more common mistakes that can be found in the article.

First is neglecting the future dilution of stocks because of stock based compensation. The number of shares today are 503 m. in 2012 it was 453. all the dilution comes from issuing shares to employees at a very low price. When you look at the p&l the cost is accounted for, but not in the CF. This will go on, so you can't use future cash flows with current shares outstanding. If you hold a 1000 shares today for ten years, your part of the CF in 2027 will be lower than it is today. You should bring that into account.

Second, and a bigger mistake, is thinking that Amazon has plenty of cash on hand. It doesn't. The cash you see on the balance sheet comes from the fact that the company is paying it's suppliers later than being paid by it's customers. That's why you have current assets of 48.6 b but current liabilities of 47 b. Working capital is only 1.6 b, and going down in recent Q's, while LT debt is being added. When the growth slows, all this cash will have to be paid to the suppliers.

This is not the case with MSFT AAPl GOOG or others . They are truly cash rich with hard cash that was earned not just received in advance . Amazon does not really have a lot of cash on hand .

I see many WS analysts doing the same mistakes, and also neglecting the payments for LT lease, so you are not alone in this, because many don't fully understand Amazon's complicated accounting.
Billy Duberstein profile picture
Just want to correct some things here for everyone:

I never said R&D isn't a cost, it's just that it is more like capital spending for tech and pharmaceutical companies. And yes, if analyzing Google, Microsoft, or Facebook you should absolutely do the same thing, though I'm not sure you should amortize those costs for as long a time period as Amazon.

This also doesn't affect FCF, but gives a blueprint for future margins in a steady state, which I think we all agree Amazon is not at yet.

Stock-based compensation is factored into my costs years 2-10, so if I added to shares outstanding it would be double-counting. I don't think that was clear in the article so wanted to clear it up here.
There is so much wrong and misleading and made up in this article, I don't know where to begin. This one quote from the author, though, pretty well sums up its value:

"This is also a tricky calculation." [Emphasis on "tricky".] Oh, and his analysis misstated the debt by $31 billion. He was low. Give me a break. How useless.

It's the day after Christmas and I'm spending time with my beautiful wife and son. Perhaps later when they tire of me, I'll do a deeper dive. Perhaps not. Not worth it.
twitterhardcorevalue profile picture
If your valuation is $1131, why the hell do you own it today at $1175?
Mingran Wang profile picture
AMZN should be treated more like a Growth stock, meaning its value is mostly from growth prospects (expectations), not from cash flows right now.

Normally a company at this size won't have much growth potential any more, but internet makes competition and reach all global. So the winner is easily much bigger than before. Also, e-commerce has even more significant economies of scales. So these two factors give Amazon a lot of growth potential going forward.

That said, I am not buying at this level because I have limited visibility here, but this could be a mistake.
Has there been any news on Amazon's Anti-Trust issues? https://bloom.bg/2ulCl4b
Gary J is Rich on AMZN profile picture
No probably because there are none.

I agree that AMZN makes sure it makes no money by "investing" in the future. Some of the investing may not have an implicit ROI, but is crazy like a fox. I personally think losing money in India to gain market share will not ever yield any economic benefit. That aside, I am not an advocate of capitalizing a tech company with an ongoing operation. But would be interested to see a DCF analysis by looking at what a sustaining level of R&D spend would do on the operations. This same thinking will pull back the growth rate from 25% to something that reflects a more mature operation (inflation rate in the US, growth through emerging and growing markets - so maybe 6%). Suspect it is no longer undervalued. That being said, I hold some shares to diversify by portfolio.
rkavanaugh profile picture
Analysis like this has actually encouraged me to add to my short. Einhorn is right - the market is wrong. Who remembers CSCO from March 2000? AMZN will also lose about $400B in market cap.
Gary J is Rich on AMZN profile picture
When? Put a date on it. We love to play back this stuff.
August 18 2018
Kirk Spano profile picture
lukelol that seems as good a date as any. I'll take the over, but definitely see a 50% decline in Amazon from here within about 3 years.
TTurk profile picture
Anybody can sell a lot of stuff below full cost. You don't have to be a visionary to do that.

You just need to sell that idea to enough people to provide you with the capital to continue doing it for a very long time.

It seems to be a very successful way to make billions of dollars.
A lot of detailed research on this. My compliments.

However: The Jiu Jitsu logic required to support your argument for AMZN's valuation reminds me of those made for CSCO in March of 2000.

AMZN is priced for perfect outcomes but may yet go higher due to momentum.

I believe they are selling dollar bills for 95 cents in a predatory effort to destroy their competitors, great for consumers but is it a good investment?

Remember: "... momentum is a cruel mistress, she can turn on a dime with the smallest mistake..."

I have to go now and use the Amazon gift card I got for Christmas
@Steve Cassaday - Your mention of Cisco is potentially relevant for Amazon. During the dot.com bubble, Cisco was a "Wall Street darling" among tech stocks given the projected rapid growth in the Internet and Cisco's dominant position in network routers and switchers.

As such, it was accorded a very high multiple with a P/E at its peak in 2000 of around 160X. With a market cap of ~ $500B, some analysts were even proclaiming that Cisco would become the first $1T market cap company. Their confidence was based on Cisco's meteoric rise in share price from $0.17 in 1991 to $65 in March 2000 (i.e., 382X).

Analysts' growth estimates turned out to be low compared to what actually happened over the next 15+ years in terms of Internet usage. Also, Cisco became a significantly larger and more profitable company that generated huge free cash flows by continuing to dominate the global market for routers and switchers.

While macro estimates about rapid Internet growth and Cisco dominance were borne out over the succeeding 15+ years, a funny thing happened to Cisco's share price and market cap. A year later in 2001, the share price had fallen to $17 (i.e., 74% decline) and today, nearly 18 years later, Cisco trades at $38.48 or 60% of its March 2000 price.

Moral of the story: Eventually, all stocks become "fairly valued" based on fundamentals rather than unrealistic estimates of future profitability and cash flows, often derived by using "different" metrics and "adjustments" to the numbers.

As a further comparison, Facebook (by no means a low multiple stock) and Amazon have approximately the same market cap. Both companies have excellent growth prospects and dominate in their respective businesses. During the past 12 months, Facebook generated about $16B in net income whereas Amazon generated $1.9B. Is Amazon really worth 8X more than Facebook based on current and projected profitability?
I don’t want to pay $563B for $17B in annual operating income. There are better deals to be had.
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