Warren Buffett (Trades, Portfolio) regularly comments on the importance of a moat when investing. A business moat helps protect the company’s high returns, and a moat that lasts for the long term is the key to attractive long-term investment returns as the enterprise in question churns out excess profits year after year.
Despite Buffett’s love of moats, however, it is ironic he appears to have missed the one business with possibly the world’s largest moat.
The company I am talking about is, of course, Amazon.com Inc. (AMZN, Financial).
It is difficult to put into words how explosive Amazon’s growth has been over the years. The online retail giant’s ever-expanding footprint has catapulted its owner, Jeff Bezos, into the position of the world’s second-wealthiest man, overtaking Buffett in the process.
In many ways, it is a mystery why Buffett has not jumped on the Amazon bandwagon. Granted, one of Buffett’s key investing rules is not to buy into a company that is loss-making, but is not Amazon’s dominance of the online retail marketplace enough to break the rule? Amazon is not your standard loss-making business. The company is hugely profitable but is choosing to give up margins at the expense of research and development and customer acquisition.
For full-year 2015, the company produced an operating cash flow of $11.9 billion, an enormous sum. For the year, Amazon reported revenue of $107 billion. There is extra cash flow available as well if the company cuts its research and development spending. For 2015, the company spent $12.5 billion on research and development and $20.4 billion on selling costs. Put simply, if Amazon really wanted to increase its profitability, it could do it quite quickly.
Avoiding the business?
So why then has Buffett avoided a business that arguably has one of the widest and deepest moats in the world? Of course, it is hard to know exactly. In fact, it seems even Buffett does not know why he avoided the business over the years, remarking when asked at the beginning of this year, "I don’t have a good answer."
One answer could be Amazon’s valuation; the stock has never been cheap by value standards, but then Buffett has always been willing to pay more for a high-quality business. Amazon is a high-quality business with a wide and deep moat; it would be easy to justify paying a premium for it.
It would be a mistake to say Buffett has never paid any attention to Amazon. While researching for this article, I stumbled across a piece in the Chicago Tribune dated April 12, 2003, which detailed an investment by Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) in Amazon.com junk bonds. Geico acquired $98.3 million of Amazon junk bonds and stood to make a return of 17% if Amazon repurchased the bonds a month after the article was published (as analysts were predicting at the time). With such a high return on offer in such a short amount of time, it is easy to see why Buffett was attracted to this deal.
Another explanation of Buffett’s lack of love for Amazon over the years may be his desire to ignore those holdings he finds too hard to evaluate. Even though Buffett is friends with Bezos, the sheer size of Amazon coupled with its high valuation and erratic profitability may all be enough to scare him away from the business.
Follow Buffett or Bezos?
The question is, should the average investor adopt a similar viewpoint? Well, as described above, Amazon has arguably the widest moat in the market today, and this moat makes it the perfect Buffett-style investment. That being said, if even Buffett himself cannot invest in the company for one reason or another, then does Amazon really qualify as a Buffett investment? Amazon may have built itself the best business moat around, but the company’s valuation and erratic profitability seem to be the biggest obstacles preventing investment. Unfortunately, by the time these two problems are solved, the majority of the stock gains may be behind us.
Disclosure: The author owns no share mentioned.
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