Thoughts after 10 Years of Investing

Below is an excerpt from a message I sent friends & family one year ago (May 25, 2017). It sparked rewarding conversations and I thank the individuals who encouraged me to keep writing.  

Dear friends and family,

“. . . the company I am placing a big bet on for the next 10 years is Amazon. There are plenty of reasons to believe in Amazon — many are familiar with the e-commerce story, the unrelenting triumph over brick & mortar stores, innovative Alexa devices, and the popular “Prime” memberships now penetrating 50% of households.   

However I believe Amazon’s greatest strengths — the mechanisms which will essentially “tax” future economic activity — have yet to be fully understood, or fully priced into the stock. Here are 3 things to consider:  

1. Cloud  

If we could travel back to the typewriter era and assert that someday there’d be “a computer on every desk” I don’t think it would have been easy to convince everyone to invest in Microsoft.

We’re in a similar state today when it comes to cloud computing. In the future, all businesses and organizations will move their data from onsite equipment or offsite datacenters to public clouds. This migration, known as “digital transformation” has barely begun as cloud penetration among enterprises is below 10%, and the opportunity is massive — in the range of $250 billion!

Cloud service offerings are quite complex, but there are a few simple takeaways for potential investors:

  • Amazon was the first company to realize this opportunity at scale. They “invented” the market in 2006 based on needs that emerged from their multiple business lines.
  • Leveraging its first-mover advantage Amazon has established a wide lead, and worst-case scenario it will remain one of very few winners in a high-growth market that is nascent and evergreen.
  • The barriers to entry for scalable cloud services are so high that only a few technology companies in the entire world can compete. Look no further than Netflix, which pays Amazon to run its entire streaming video business on the cloud platform. This is just one example of Amazon’s ability to “tax” economic activity.

We live in a world where Uber is valued at $70 billion, though it has yet to turn a profit. In comparison Amazon’s cloud business achieves similar revenue, similar growth rates, is already profitable, and generates margins that are actually expanding on a quarterly basis.

2. Services

Amazon has spent 20 years convincing consumers to make its site the first place to look for any product. But few people realize just how far Amazon plans to extend that behavior to services.

Recently I visited and discovered that in addition to food delivery and housecleaning, Amazon will send someone to install a basketball hoop in your driveway. What are the profit margins on basketball hoop installation? I have no idea, and would bet they are pretty low.

However the bigger picture is that Amazon has the financial resources, operational infrastructure, and massive customer database to sell almost anything it wants to. Imagine a world where Amazon is not just the place you go to purchase accessories for your car, but also the car itself, as well as the insurance. That may sound like a stretch today, but friends who work at major insurance companies have told me executives are already deeply concerned.

In the next decade, Amazon will leverage its dominant position and unique resources to enter a wider range of service businesses than most people realize. Not every venture will be profitable, but it will be relatively easy for Amazon to enter, learn from, or withdraw from any venture it chooses. Further, it may be able to generate better revenues and/or profitability upon entering traditional industries like insurance by leveraging its unique assets. There are a multitude of possibilities to be considered here, as the history of business has not yet seen a company quite like Amazon.

3. Fulfillment, Marketplace & Shipping

This article, Why Amazon is Eating the World articulates Amazon’s strategy of “productizing” services like shipping, and explains why Amazon is one of the “least understood” companies in the world. It’s worth a read if you’re at all curious, and especially if you are considering investing.  

The elephant in the room. . .

Screenshot 2018-05-17 at 5.57.46 PM

I’d be remiss not to mention the sticker price on Amazon stock (currently trading at $992 per share). A thousand dollars is a hefty sum to commit to almost anything. However it’d be better to invest that amount in even one share of Amazon if it grows to its potential over the next few years, as opposed to other places to park your savings that may stagnate, lag inflation, or grow at a slower rate.

I truly believe that over time, Amazon stock will magnificently outperform the broader market (similar to the bet I placed on Visa last decade). And if it does grow 500% in the future it won’t matter if your entry point today was $990 or $850 or even $1,100.

That said, there are a few scenarios where the stock price may become more affordable:

  • Eventually Amazon may do a stock split (as Apple and Google have done in recent years when their stocks traded near $1,000).
  • Rumors are circulating that Amazon will be added to the Dow Jones Industrial Average, which would likely be preceded by a 10:1 stock split to bring the share price in line with “peers” in that class.
  • Recently the stock price has run up tremendously (up 33% year to date) and some analysts feel it is overvalued at today’s prices. A short-term pullback is very plausible.
  • Geopolitical risk — the tenuous state of global affairs have the potential to shake the market (impeachment anyone?). We’re also approaching 10 years since the last U.S. recession. That said, Amazon’s stock price has tended to remain relatively stable on market down days, a signal of Wall Street’s confidence in its long-term fundamentals.

The other elephant in the room

I believe the only long-term threat to Amazon’s growth story is government regulation. Admittedly I don’t know much about antitrust law, nor can I speculate on how regulation would impact Amazon investors.

What I do know is Amazon would be a tricky beast for any government to regulate. For example, Amazon’s Cloud business has relatively high margins and subsidizes long-term investments like Prime video and the low-margin e-commerce operation. It’s tough to envision a government applying traditional antitrust measures to Amazon (though with this administration anything is possible 🙂 )

My hope is that potential regulation would happen slowly enough for anyone to make adjustments, if necessary. In the meantime I’ll continue to invest with measured optimism.

Quick notes on other companies

  • Visa: My view of Amazon should not overshadow the fact that Visa remains an excellent investment opportunity. I’ve been buying Visa stock every year since 2008 and have never sold. Considering that innovations in the payment space (Paypal, Apple Pay, Venmo, Square, etc.) have been unable to disintermediate Visa from the transaction cycle, I anticipate holding Visa stock for years to come.  
  • Netflix: Conversely, I believe Netflix is screwed. Amazon is planning to spend $5 billion on acquiring video content this year. Imagine a world where all of the TV shows and movies available on Netflix are also available on Amazon Prime. Why would consumers pay Netflix $10 every month when Amazon Prime Video comes with things like free shipping, Alexa services, 5% cashback & more for the same price?
  • Therefore, Netflix will need to work hard to produce “hit” video content not available elsewhere. Competing financially with Amazon to bid for the world’s best writers, actors and video content is already challenging, and this war is just beginning. If even 20% of Netflix customers churn away, its financial capabilities would weaken, further limiting its ability to generate exclusive “hits.” This eventual downward spiral appears inevitable, and the amazing irony here is that due to the Cloud business model, Netflix is literally paying Amazon to steal its customers away. In my opinion, the best-case scenario for Netflix is to get acquired, perhaps by a company like Apple or Disney.   
  • Facebook: As soon as I began understanding the emerging trend of “Big Data” I sold my entire position of Facebook stock. This has nothing to do with the future of Facebook’s users and everything to do with its advertisers (who provide 98% of its revenue). My theory is that in a perfectly optimized “Big Data” world, Facebook’s value proposition to advertisers (demographic targeting infused with rich social data) will be weakened.
  • If there are data-collecting sensors everywhere, from fitbits on our wrists to ridesharing apps that track every place we visit, Facebook’s insight that someone “Liked” the local gym becomes less relevant. Facebook will likely remain ingrained in our daily lives, a staple on our devices, and generate lots of revenue. But over time it’s reasonable to expect that its pricing power with advertisers will be compromised, therefore I’d rather not invest in its stock.
  • Snapchat: Some of you may remember I was very bullish on Snapchat approximately two years ago. My perspective changed long before the IPO, but I didn’t have a chance to voice that opinion before the bottom fell out. When it comes to growing revenues over the long-term Snapchat is even worse-positioned than Facebook, and could become the next Twitter, unfortunately.
  • Alibaba: If you like the Amazon story, have a long-term horizon, and want exposure to China, I highly recommend investing in Alibaba. There’s a lot more risk involved and I expect this stock to be quite volatile in the coming years. But China is poised to become the world’s #1 economy during the next decade, and Alibaba is one of the soundest ways to profit from that shift.

Final Thoughts

Perhaps this email comes as a surprise to you, but I’ve written it with sincere intentions to help as many people as possible.

The opinions are completely my own, backed up by my life’s work and savings, and I encourage you to vet the suggestions with a financial professional if necessary. (Just don’t let them charge you any money to invest in these stocks, which you can easily do on your own for less than $10 🙂 )

If you would like to discuss any of these concepts further, e-mail me back and I’ll try to reply within a reasonable timeframe. Otherwise, Happy Memorial Day and here’s to the next 10 years 🙂 )

— May 25, 2017