Today I started reflecting on Amazon and Apple. I’ve been shopping on both of their websites as Christmas inches closer and I started thinking about how difficult Amazon is to value. Much like LinkedIn (LNKD), it’s a company and a business model that I love but that I find very difficult to put in context. They both seem very expensive on the surface but have incredible growth potential. Back to Amazon and Apple. One company has sky-high margins, is piling money like there’s no tomorrow and focused on a few key products. The other one is doing almost exactly the opposite. It’s fascinating and I thought I’d take a deeper look.. I’d love to get your thoughts:
[ Enlarge Image ]Apple ModelThe Apple model is much more similar to what we’re used to. After turning the company around, Steve Jobs gave a clear vision by working on a handful of key products that were significantly superior to alternatives in every possible way (design, ease of use, experience, etc). That helped Apple build an incredible brand, an army of fans that continues to be impressed by the latest releases. Apple could virtually launch any type of product and have a huge success no matter how it is priced, etc.
The big downside though is that it could change over time, especially if Apple ends up releasing a product that lacks its usual quality. The recent Apple maps fiasco in the latest iOs was one such example. Get a few more like those and you could see a major shift.
I do think that the Apple model is fairly easy to evaluate. You have a company that generates $X, growing at X%. You can then compare the P/E ratio to other competitors which has personally led me to become a major believer in the stock in recent months.
Amazon modelAmazon is a very different model by comparison. It started off in the physical book business and gradually became dominant. At that point it started moving to other industries selling different products through its main brand but also sub-brands such as Zappos.com, Diapers.com, etc. All of those have given Amazon a dominant position in much of the ecommerce business.
What Happened Next?After taking a strong position in the physical book market, Amazon was able to slowly but surely take down most national bookstores such as Barnes & Nobles. It then moved to ebooks, a market that Amazon completely dominates. The company continues to face off and win in many different spaces for cloths, books (now even getting into book publishing), video, cloud computing, it now also competes with Netflix, is getting into local shopping, etc.
How Amazon Destroys CompetitionThere are numerous examples where Amazon is more than willing to sell at no profit or even at a loss. Why?
-To establish itself as a low cost leader
-To destroy competitors such as Barnes and Nobles, Best Buy, etc
-Because it can..
One such example is the Kindle which Jeff Bezos has admitted not even trying to make a profit on. Then Netflix has accused Amazon of losing $1B/year on its video streaming service. Amazon also ships a lot of its merchandise at a loss. Who knows what else Amazon is losing money on. What does seem clear is that it is driving many competitors out of business which could mean higher margins in the future.
In The MeantimeI struggle valuing Amazon because its EPS is basically meaningless. As long as Amazon keeps pumping money into losing businesses to destroy competition and increase its capabilities, market share, etc. EPS will remain somewhat irrelevant. What is important is:
-Will Amazon start focusing on earnings per share at some point and what would happen if that was the case?
I guess no one has the answer to that question but clearly many including myself think it will happen at some point. If we didn’t, Amazon (AMZN) would be an obvious short at its current valuation…