The roiling stock market of 2000 appears to have rattled Jeff Bezos and Amazon.com (AMZN, Financial). “Ouch. It’s been a brutal year for many in the capital markets and certainly for Amazon.com shareholders,” Bezos then wrote.
At the time he wrote the 2000 Shareholder Letter, the stock price was down 80% from the previous year. Nevertheless, he pointed out improvements in the metrics that mattered. They included serving 20 million customers in 2000 versus 14 million in 1999. Sales grew from $1.64 billion to $2.76 billion, and the pro forma operating loss was 2% of sales in the final quarter versus 26% of sales in the fourth quarter of 1999.
The list goes on, all of which suggested operations were going one way and the share price another. Bezos explained the apparent contradiction by quoting Benjamin Graham, ““In the short term, the stock market is a voting machine; in the long term, it’s a weighing machine.’’ Clearly, there was a lot of voting going on in the boom year of 1999 snd much less weighing.
Two companies lost in the voting were living.com and Pets.com, both of which had been purchased a few years earlier by Amazon. According to Bezos, he and his team passionately believed in the “land rush” metaphor for the Internet in the mid- and late-1990s. It was a time when, like the California and the Klondike gold rushes, many wanted to stake their claims before it was too late.
But, the capital markets quit financing Internet companies, and when Amazon decided not to put any more of its own capital into them, they had to close. Bezos admits they significantly underestimated the time and difficulty involved in achieving the scale necessary to build these into successful businesses. Consequently, Amazon lost a “significant” amount on each of these online ventures. One might also argue that Bezos and team had no long-term vision for these companies.
Bold bets would, nevertheless, remain an important part of Amazon’s DNA. There were also lessons to be taken from or reinforced by the experience. The most important of them was derived from the business structure: Bezos said, “Online selling (relative to traditional retailing) is a scale business characterized by high fixed costs and relatively low variable costs. This makes it difficult to be a medium-sized e-commerce company.”
It is within that context Bezos goes on to talk about the future in the 2000 Letter. He aptly titled a section of the letter, “Future: Real Estate Doesn’t Obey Moore’s Law.” Often cited in the 1990s, Moore’s Law referred to innovation and productivity in computing power, specifically that the price performance of processing power doubles every year and a half. Bezos adds the price performance of disk space was roughly doubling every 12 months and the price performance of bandwidth was doubling roughly every nine months.
On the other hand, physical retail had little price-performance improvement. They can use technology to cut costs but not to “transform” the customer experience. Thus, Bezos sees a substantial competitive advantage for online retailers, and one that should grow. In the 2000 Letter, he forecasts some 15% of bricks-and-mortar business will be captured by online merchants.
One of the ongoing bold bets, then, was to continue investing heavily in technology to establish an online beachhead. It also explains why Bezos was never in a hurry to be profitable; it was more important to him to exploit the newly developing online e-commerce milieu.
Bezos’ bold bets go beyond technology and business operations. He told Henry Blodget, in a 2014 interview, that he does not meet with some of Amazon’s biggest investors, instead he prefers to meet with investors who have low portfolio turnover. He calls investment funds with high turnover “traders” not “investors”.
Returning to other bold bets, Bezos admitted in the Blodget interview, “I've made billions of dollars of failures at Amazon.com. Literally billions of dollars of failures.” He compared these failures with getting a root canal with no anesthesia but emphasizes failures also don’t matter.
What does matter, he said, is that companies keep experimenting. Failures are bound to happen when you experiment, yet they can’t stop experimenting because they begin stagnating, and finally try a Hail Mary bet just before they lock the doors for the last time
A few years ago, one of those bold bets, the Amazon Fire Phone, failed when it went to market, generating much media and market attention. Bezos, however, was unperturbed when asked about this failure. He said one of his jobs as the leader of Amazon was to be bold and you never know in advance if bold bets are going to pay off.
He also pointed out that other experiments had been successful, including both products and services such as Kindle e-readers and Amazon Prime. The returns from successful products have provided huge sums that can be invested in new experiments, including Fire Phone.
This last point begs a couple of important questions, including:
- How does a leader balance successes and failures?
- How long will losers be allowed to run?
Fortunately, as investors we have a tool to find out how management has done in making these choices: Return on Assets (ROA). Investopedia says ROA is theoretically similar to Return on Equity (ROE), but ROA is not so influenced by recent performance (current net income and last year’s net income).
This GuruFocus chart shows how ROA has varied over Amazon’s life as a publicly-traded company:
And this chart shows how Amazon compares with other prominent retailers (not all of them depend so much on online revenue):
Note that Ulta Beauty (ULTA, Financial), O’Reilly Automotive (ORLY, Financial) and others best Amazon in a head-to-head match on ROA. That seems logical because the former two are more mature retailers, which have done well with bricks-and-mortar and then added an online presence. And although Amazon is well over 20 years old, it continues to experiment.
All of this points to Amazon as a growth stock, a company still driven by expansion dreams. The recent acquisition of Whole Foods and checkout-free retail locations demonstrate that experimentation continues, with losses from failures and profits from successful experiments.
As long as the experiments last, especially those on a grand scale, there will be losses. Given Amazon’s history, successes should continue to subsidize losses, but profitability will be dampened.
What’s intriguing here is to ask how profitable Amazon will be, once Jeff Bezos has decided to stop making bold bets. But will he ever stop?
Disclosure: I do not shares of any companies listed and do not expect to buy any in the next 72 hours.
