100 Baggers: The Amazon Case Study

A great manager, a growing addressable market and very profitable operations were arguments for an early investment

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Jan 04, 2019
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Spotting a "100 bagger" is not an easy thing. But holding one for the long term is much harder.

Chris Mayer, in his book, “100 Baggers,” presented six case studies of companies that have provided a $100 return for every $1 invested. Monster Beverage, Amazon, Electronic Arts, Comcast, Pepsi and Gillete were thoroughly analyzed with the objective of identifying the factors that could have led an investor to select and hold them for the long term. Let's focus on the Amazon (AMZN, Financial) example.

The Amazon case study

Amazon was a 100 bagger more than twice over. It started trading in May 1997. Before the century ended it was already a 100 bagger. But then it crashed from $221 to single digits in the middle of 2001. It took 13 years to become again a 100 bagger again. So, what characteristics were there that contributed for this excellent result that an investor could have identified a priori?

The manager: Bezos

Jeff Bezos started the company when he was 30. He used to work at DE Shaw, an investment management company. Importantly, he’s not a programmer like Bill Gates (Trades, Portfolio). “He’s a Wall Street guy in a lot of ways,” Mayer wrote.

“At heart, he understands two things (…) the value of a business is the sum of its future free cash flows, discounted back to the present. And he understands capital allocation and the importance of return on invested capital,” Mayer wrote. The importance of these notions were highlighted several times in Amazon’s Annual Letters.

Addressable market

The online retail opportunity is gigantic. After years of extraordinary growth, according to eMarketer, the market still represents only 10% of the overall retail market.

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Does it make money?

Many believe it grows sales but doesn’t produce operating income.

But that’s not true. Amazon has grown sales significantly at a compounded annual rate of over 40% since 1997. And in 2014, for example, it “earned a measly $178 million in operating income. That’s a razor-thin 0.20% operating margin.”

But, “Adding back R&D, however, paints a completely different picture. In 2014, Amazon spent $9.2 billion on R&D. Adding that back to operating income, Amazon generated adjusted operating income of $9.4 billion in 2014. That’s an operating margin of 10.6%,” Mayer said in his book.

Over the previous 10 years, using this adjustment, margins stood in the 9-10% range. The adjustment is justified because GAAP demands R&D expenses be expensed in the year they occur. But we know that some or most of these (although not all of them) are long-term investments and, as with capex, their returns will occur over the years. So, this is not a cost of the years that they occur but an investment that should be recognized over several years.

Could it have been bought at the right price?

It could have been, if you waited patiently. In early 2003, Amazon’s stock corrected significantly in the aftermath of the dot-com bust. Sales were growing 26% (to $3.9 billion), adjusted operating margin was 7% and online retail was a small fraction of total retail sales. With an enterprise value of $8.3 billion, Amazon was trading at 33x adjusted Ebit. But if one projected that sales would increase at 30% a year for the next two years and that the adjusted operating margin would be maintained at 10%, it would mean that Amazon was trading at 10x its adjusted operating income for 2005 -- a conservative multiple.

Conclusion

Spotting 100 baggers is not an easy thing. The process highlights the importance of deep thinking and the capacity of looking several years into the future. Amazon is the example of a company that invests for the long term, that grows its moat everyday and that has very profitable operations.

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