Amazon: Habit-forming and habit-changing
An investing conference looks at why the online retailer is so successful.
Investing on some level is a never-ending pursuit to get better.
Most of us are locked up in air-conditioned offices where we learn through reading SEC filings, magazines and blogs. Though reading is important, it should not be a substitute for interaction and debate with other investors. That is why, for the second year in a row, I organized a conference in sunny (and at the time, wildfire-threatened) Vail, Colo.
For three evenings we listened to half a dozen well-researched presentations, followed up by 10-minute question and answer discussion sessions. You can find all presentations here.
Here are some thoughts on what I learned about one stock in particular: Amazon (AMZN).
The conference started with a presentation by Josh Tarasoff (here is a link to a PDF), whose long stock idea was Amazon -- at the time trading at a modest 179 times trailing earnings.
Amazon is one of the best-managed and the most innovative companies in the U.S., if not globally. It constantly pushes the boundaries. It went into cloud hosting because it felt it had unique expertise running its own enormous website, and now Amazon is going into supply -- it will ship goods to you if you run a retail operation.
Josh's take on Amazon was that it changes the way we shop. Our normal brick-and-mortar shopping habits are simple: We go to stores where the merchants have performed their black ar" of merchandise selection, trying to maximize their limited real estate to have the highest appeal to the average shopper (to be more precise: the shopper with the largest wallet).
Amazon doesn’t try to appeal to the average shopper or to the wealthiest one. Instead, it appeals to the most important shopper: you. Its merchandising strategy is simple: supply everything. With the Internet and thus Amazon being on our smart phones, tablets and PCs, we can shop on Amazon instantly whenever we realize we need something.
Amazon is habit-forming for younger generations and habit-changing for older ones. This way to shop will gradually become embedded into the DNA of younger generations. A few days ago I needed an iPhone car charger. I didn't add it to my mental shopping list of things to buy next time I go to Best Buy. I simply fired up the Amazon app on my iPhone and bought it. I almost cannot think of a second website where I’d go if I needed to buy something. I might Google it if it was an expensive item; if not I’d just go directly to Amazon.
Amazon's cost structure puts it at a competitive advantage against other retailers. The thing I find very refreshing about Amazon is that it allows its competitors to post merchandise on the Amazon website -- they can even do so at lower prices if they like. If a customer buys the competitor’s product, Amazon still makes a commission on the sale. Though we’ve been conditioned by Amazon to think of this as a normal way of doing business online, think about how this would look in the brick-and-mortar setting. Imagine Kohl's allowing Target to put their pair of Nike shoes right next to Kohl’s pair of the same shoes, at a lower price.
Josh’s argument was that while online shopping now has only a 3% market share of total retail sales, sometime down the road it will have 20%. Amazon, he believes, will grow at a faster rate than the overall online shopping market. He pointed out that Amazon’s growth rate actually accelerated over the last few years. Smart phones and tablets were probably the accelerators, as they provide instant online access to the world’s largest store and are great price-comparison tools (especially if you are visiting a Best Buy store).
Josh’s Amazon’s investment story is not only dependent on future sales but on its margins expanding -- they’ve declined from 4.6% in 2010 to 1.8% in 2011. Josh believes that growth and investments in new projects are depressing margins.
You may agree or disagree with Josh’s case for Amazon, but it demonstrates his ability to think outside the value box. Josh considers himself a value investor and believes there is value in Amazon; you just need to have a very long time horizon. There is value in growth, however, when the bulk of a company’s value lies in the significant growth of future cash flows. Your confidence level in the sustainability of high growth has to be incredibly high, however, as a small change in growth assumptions will tank the stock.
The Amazon story is interesting to me for a different reason. Not unlike the Apple iPhone that went through and rearranged all the players in the cell phone industry, Amazon is like a huge plow that is ripping through the retailer industry and transforming it and other industries (it has already changed the book business). I wrote recently about Best Buy, but Best Buy is the low-hanging fruit, the obvious casualty. I keep thinking, which industry will be next?
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here or read his articles here.
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