Amazon.com Inc. (AMZN) has been one of the best-performing stocks in 2020. Amid the market volatility and recession fears, shares of this e-commerce behemoth have gained a staggering 25%.
The primary reason behind this positive performance seems to be the lockdown-proof nature of Amazon’s business model. In fact, the global lockdown is expected to boost the profitability of the company as consumers are forced to purchase products online while companies are increasingly turning toward cloud computing to facilitate the stay-at-home economy.
Bill Miller, the founder of Miller Value Partners (Trades, Portfolio) and the former chairman of Legg Mason Capital Management, believes Amazon’s market value could double in three years thanks to the company’s efforts to immunize itself from pandemics and its market-leading position in the cloud computing industry. According to data from GuruFocus, Amazon is the largest position in the guru’s portfolio. Other gurus bullish on the stock include Warren Buffett's Berkshire Hathaway Inc. (BRK.A) (BRK.B).
Miller says the market is not dramatically overvalued
The market performance since March 23 has been stellar, despite recessionary economic conditions. Some analysts believe there is a disconnect between the economy and the market due to record levels of unemployment in the United States and the first-quarter GDP contraction of -4.8%. Meanwhile, the S&P 500 index has gained 30% since March 23.
However, Bill Miller holds a different opinion. Appearing on CNBC on May 13, the guru said:
“If you look at the overall market, we are trading around 17 times the consensus on bottom-up earnings for 2021, which is about the average for the last five years. It might be a little extended given we’ve got a chasm of bad news to go over here, but I don’t find is as dramatically overvalued as others.”
Amazon will likely be a beneficiary of a broad market rally as the company, is the third-largest constituent of the S&P 500 index behind Microsoft Corporation (MSFT) and Apple Inc. (AAPL, Financial).
Valuing Amazon based on earnings multiples might not be prudent
Value investors have tried to gauge a measure of Amazon’s intrinsic value by using price-earnings ratios. However, Amazon is a unique company, and its growth numbers are stellar, despite being a billion-dollar company. The revenue of the company has grown at an annualized rate of 24.8% in the last 10 years.
Source: GuruFocus
Investors often associate these numbers with small companies, but Amazon is not a small company by any stretch of the imagination. In 2010, the company brought in just over $34 billion in revenue. In comparison, the total revenue of the company was over $280 billion in 2019. This unprecedented growth in revenue has translated into the net income as well, and the company has grown its earnings from $1.1 billion in 2010 to $11.5 billion in 2019.
One could argue that the price-earnings ratio of above 110 is an indication of shares trading at overvalued territory. In my opinion, though, a better way to look at Amazon is to evaluate what the company is doing with its earnings.
Amazon does not pay any dividends and the company has not repurchased shares for the last five years. This, arguably, is the best outcome for an investor as long as the company can create wealth at a faster rate than the dividend reinvestment return of an investor. In his 2012 annual letter to shareholders, Warren Buffett (Trades, Portfolio) highlighted that a company should prioritize reinvesting in the business over dividends and buybacks:
“A profitable company can allocate its earnings in various ways (which are not mutually exclusive). A company’s management should first examine reinvestment possibilities offered by its current business – projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors.”
Amazon is sticking to this principle. The return on invested capital has trended upwards since 2012 and was above 10% for 2019, which is a clear indication that the company has successfully deployed capital in this period. The company has also been relentlessly expanding its scale through acquisitions.
Source: CBI Insights
Amazon is no longer just an e-commerce store. For instance, the video streaming arm of the company, Amazon Prime Video, is the second-largest over-the-top content platform in the United States, according to data from e-Marketer. Twitch, which is the leading live streaming platform for gamers, is a subsidiary of Amazon. The company is diversifying into various high-tech business sectors and its strategy is to be the number one player in all of the markets it has a presence in.
Below are some of the lesser-known businesses that Amazon owns.
| Company | Profile |
| Audible | The largest producer and retailer of audiobooks in the United States. |
| CreateSpace | The company offers a self-publishing platform that allows independent filmmakers, musicians and authors to publish and distribute their work. |
| Goodreads | An online community of book readers and many self-published authors use the platform to promote their work. |
| IMDB | An online database that provides information on TV series and movies. |
| Whole Foods | Organic food retailer that has a strong brand image among health-conscious consumers. |
| Woot | Online discount retailer. |
| Zappos | Online shoe store. |
Source: Company filings
The company, as confirmed by the management, is looking at more ways to expand in the coming years. Increasing the contribution from the international segment to revenue is one of the primary objectives of the company. According to company filings, the United States accounted for 61% of company revenue in the last 12 months, and the plan is to unlock value from its acquisitions in developing regions of the world. For example, the company has a presence in the high-growth Indian market through its investments in Future Retail and More. The company is the leading e-commerce player in the Middle East as well, which was achieved through its investment in Souq.
I believe the sky-high earnings multiples will eventually come down as the company brings in more earnings from its investments. For now, the company is focused on expanding its scale in all the global markets it operates in. Growth is likely to come from two fronts: market share gains in the online retail industry and higher penetration in other business sectors.
Takeaway
As the global leader in the online shopping space, Amazon is benefiting from mobility restrictions. Its cloud computing segment is also experiencing higher-than-expected growth as a result of companies adapting to the stay-at-home economy.
Bill Miller believes that these developments will push the stock price to more than $4,000 within the next two years and that the billion-dollar investments will help Amazon’s growth story as well. Thus, until growth decelerates, using an earnings-based approach to value Amazon might not be prudent. In my opinion, a better alternative would be to use a price-sales approach or a discounted cash flow method.
Disclosure: I do not own any shares mentioned in this article.
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