Should you invest in Amazon?

Posted on 02 November, 2023 . 15 min read

Great, thank you for joining us today. Chandan and I are going to discuss a little bit about Amazon's stock — its current value, what the fair value is today, what an optimistic scenario might look like, and the less optimistic, or pessimistic, scenario. We're happy to answer any questions you might have on that. Just to introduce ourselves quickly, I'm Gagan, the CEO of Xillion. Chandan, could you give a brief intro about yourself before we dive in?

Hi, my name is Chandan Malu. I'm a co-founder of and have experience working at Amazon and Twitter. This area, especially stock investing, excites me. I believe it's an excellent avenue for passive income and long-term wealth compounding. I'm thrilled to collaborate with Gagan.

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Okay, let's jump into Amazon. If you have questions, feel free to type them in the chat.

Amazon represents a fantastic success story, from its humble beginnings 28 years ago to a giant in the industry. This company has consistently grown and improved over time. In the trailing 12 months, Amazon is on track to generate close to $600 billion in revenue. It's astonishing — I remember when Walmart seemed unbeatable as America's biggest company, but Amazon has surpassed Walmart in terms of revenue. They're a behemoth.

You can see their scorching growth in the early years, with revenue increases in the 30s and 40s percentage points. Although growth slowed down, it's picked up again, which I'll discuss more in a bit. About 30% of their revenue comes from online retail, with the rest coming from other products added later. It's a truly remarkable story, and as we look at 2022, there's more to see.

There was a period of slower growth for Amazon, where it dipped to single digits. But then, it gradually started to accelerate again. I pay a lot of attention to the price-to-sales ratio. Amazon's price-to-sales — which measures the company's worth against its annual revenue — is quite telling. For instance, if Amazon is valued at $1.4 trillion and its annual revenue is more than $500 billion, then their market cap divided by annual sales gives us the price-to-sales ratio. It's a useful metric for comparing companies.

Amazon's price-to-sales ratio sits at about 2.4. When you look at the retail sector as a whole, companies like Walmart, Costco, and even eBay to an extent, have price-to-sales ratios ranging from 0.5 to 1.5, maybe 2. Amazon's ratio is higher because it's more than just a retail company, which we'll get into. Tech companies like Google and Netflix have higher price-to-sales ratios around 6, and it's common for tech companies to range from 5 to 10. Microsoft, being less cyclical, has even higher ratios and margins.

Retail margins are around 5%, so their price-to-sales ratios are lower, but tech companies have higher margins, thus their ratios are higher. I prefer looking at price-to-sales over price-to-earnings because earnings can be influenced by changes in investment — a company can boost its earnings by simply investing less. Fortunately, Amazon isn't that kind of company. It continues to reinvest heavily into its business, securing future growth by reinvesting today's profits. Any questions on this?

Let's talk about operating profit. Amazon doesn't aim for large profits; instead, they prefer to reinvest. Earlier this year, they spent about $10 billion to acquire One Medical, which is their foray into healthcare. They consistently invest in building more warehouses, more data centers, and despite this strategy, they still generate $11 billion in profit. That's a testament to their inherent profitability.

Chandan, would you like to add anything?

I think Amazon's success, even as a massive business with $500 billion in sales and a trillion-dollar valuation, growing at a low teens rate, is incredible. It's very difficult to maintain that rate of growth. Amazon's strength lies in its cash flows. They have significant cash flows because they pay their suppliers usually 30 to 50 days after receiving the cash from sales, resulting in negative working capital, which boosts Amazon's business.

That's true for all retailers to some extent; they have a cash buffer because of their payment terms with vendors. If you look at the price-to-earnings ratio for Amazon, you'll notice volatility. But if you look at the price to operating cash flow, there's a strong trend that explains why Amazon is such an effective compounder.

Now, let's talk about tailwinds. Amazon is growing for several reasons. First, they have a very competent team — Chandan being a former part of it, you can be assured of that. Second, Amazon has a knack for identifying trends and capitalizing on them. One of the greatest trends we've seen is the rise of online commerce. Online retail sales still account for about 22% of all sales. I believe this could rise to around 50% in the US, and it's already over 60% in China, although the pandemic has skewed these figures as people were forced to shop online.

There's still plenty of growth potential for online sales, which could double in the next five to ten years. That's a significant tailwind for Amazon. Amazon takes the lion's share of e-commerce growth, outcompeting others with its pricing power and customer obsession, continually gaining market share.

Absolutely, and that customer obsession is evident in everyday life. For instance, when I suggested to my wife that we could cancel our Prime membership, she said she'd 'kill me' — that's a simple yet powerful testament to Amazon's customer focus. Even though I argued that receiving packages three days later isn't a big deal, she insisted on next-day delivery. Amazon's investments in logistics, like second-day shipping, have really paid off in the long term. Because they've always been cash flow positive and customer-centric, they've managed to stay ahead of the curve.

Other tailwinds — and we could call these tailwinds or perhaps 'artificial tailwinds' — are those that Amazon likes to create for itself. For instance, in 2018, they acquired a company called PillPack, a small but burgeoning online pharmacy. They used this acquisition to launch Amazon Pharmacy. To give you an idea of the industry’s reaction: shares of competing companies dropped significantly. For example, CVS shares fell by 20.7% the day Amazon announced this move, and Walgreens shares dropped by 10%. It illustrates Amazon's influence; although it’s a relatively small player in pharmacy now, they’ve created a new product line that I believe will be a $100 billion business for them in the next 10 years. They have the online presence, the trust, and the regulatory know-how. It seems they’re either catching the wind or making it blow in their direction.

The same goes for healthcare. They acquired One Medical, a San Francisco-based healthcare startup, for $10 billion. Currently, One Medical operates as it did before the acquisition, but it's one of Amazon's significant bets. Right, Chandan?

Yes, Amazon has a remarkable history of acquiring businesses and turning them into something great. That's the magic of Amazon, and it's known as the 'Amazon effect'. When Amazon enters a market, competitors' shares tend to plunge — it's a consistent pattern.

Amazon has a successful track record with mergers and acquisitions. They seem to know precisely when to double down.

Since then, Rite Aid has come close to bankruptcy. They might be the first major casualty of Amazon's expansion into pharmacy. CVS and Walgreens have also seen their stock prices fall. These two bets by Amazon could hugely impact healthcare, although I'm a bit skeptical because regulators can be tough. For example, Walmart faced resistance when it wanted to start banking services and health clinics. But with pharmacy, Amazon seems to be on a clear path.

Also, internationally, if the U.S. has 20% online retail penetration, the rest of the world, apart from China, is lower. Europe, India, Latin America — they all offer significant growth opportunities for Amazon. This is what I mean by Amazon creating its own tailwinds.

Here we have the product revenues broken down by category. Going back to 2015, online retail was about 70%, with another 10% for the marketplace and AWS, and the rest was too small to be significant. If we extrapolate back to 2010, AWS was just a fledgling service, and subscriptions weren't even on the radar.

Now, AWS alone is close to a $100 billion revenue run rate with 10% growth. The marketplace has also grown and is more profitable for Amazon, as they sometimes don’t carry inventory. The ads business is nearing $1 billion. Fast forward five years, and you can add another potential $100 billion from pharmacy.

Although online retail growth has been modest and even declined in 2021, other business units are skyrocketing. There isn't a flatline here, which makes me believe that Amazon still has considerable growth potential.

When valuing Amazon, which is currently worth about $1.4 trillion, I think you have to compare each segment to its peers. The retail part should be compared with Costco and Walmart, the marketplace with eBay and Etsy, AWS with Microsoft and Oracle, the ads business with Google and Meta, and the subscription service with Netflix. That's how it makes sense to think of Amazon — it's like one Costco plus one Google plus one Oracle plus half a Microsoft plus one Netflix. That's how we should approach its valuation. Chandan, anything to add there?

You summed it up pretty well, Gagan. For Amazon, you need to look at the sum-of-parts valuation to understand each business segment and what those multiples look like. That's how you arrive at an accurate intrinsic value.

Alright, and on the flip side, there are some headwinds as well. The first is the law of large numbers. When you're a $600 billion company, you're approaching trillion-dollar territory, and at some point, you might run out of things to sell. If you're offering everything from little Timmy's toys to the latest movies, you have to wonder about the American economy’s capacity for consumption.

I would say that, given the American economy purchases five to six trillion dollars worth of goods annually, Amazon is bound to run into the limits of market size at some point. That's why we see that the online retail segment isn't growing very quickly. People have loyalty to brands like Costco, IKEA, or Walmart, and if they're situated close to these stores, Amazon might not easily take away that business. There's definitely a headwind there. You reach your maximum, and you're done. This also plays into the fact that there aren't many new, large markets left for Amazon to capture. I mean, is Amazon going to build cars? I don't think so. Even in areas like sports streaming, which are comparatively smaller markets, Amazon's complete capture would only add maybe five to ten billion in revenue, which isn't as impactful as some of their other ventures. Chandan, do you want to share your thoughts on this?

Well, they are branching out into physical stores and now this Amazon satellite project, so there are initiatives like the smart devices segment where Amazon is slowly building its presence. We'll see how it pans out, but there are growth levers Amazon has yet to pull. Health is one area, but as you mentioned, some projects like Echo have been wound down. Not everything Amazon touches turns to gold, but Echo was a success story until a few years ago. Now, it's more of a cost to the company than a profit generator. However, Jeff Bezos's vision was to capture mindshare and have customers use Amazon in as many ways as possible, ensuring they return to Amazon and drive more sales.

I'm glad you mentioned Jeff's departure from Amazon to pursue other interests. Founders often have the biggest impact on a company. With Jeff at the helm, Amazon was synonymous with innovation. I remember when Amazon launched a smartphone years ago. It was a flop, but the lessons learned contributed to the development of devices like the Echo speaker. The big question is whether the new CEO and those who follow will take the same risks, have the same passion, and, most importantly, have a deep understanding of customers. When founders leave, companies often shift their focus to profitability, take fewer risks, and listen more to Wall Street. This is a risk for Amazon too, as the market always prices these things in. We haven't seen many new groundbreaking products from Amazon lately, besides their advertising segment.

To take a step back, every product takes time to mature. AWS has been around for 15 years and only now has it reached a $20 billion quarterly run rate. So, things are in motion; it's just a matter of momentum. AI and robotics, especially in Amazon's fulfillment centers, are areas that will likely grow and compound. One thing Amazon does well is keeping customers engaged and making sure they don't leave the platform. It's about creating a sticky, shared ecosystem, and Amazon excels at that.

Even though Jeff has left, the culture he instilled, like the principle of frugality, persists. Andrew Jassy and the team are wonderful. Investments are made based on return profiles, and decisions are frugally considered.

The ultimate test of Jeff's success will be if the CEOs who follow can replicate or even exceed the success he achieved. That would be the real triumph. And again, no slight to Microsoft, but Microsoft experienced a change in direction for the better under Satya Nadella after Steve Ballmer's tenure. Ballmer, being finance-driven, had a different focus, which shifted once Satya took the lead. We've seen a similar hope with Andy, who has been with Amazon for a long time, to be a replica of Jeff in that sense.

A considerable headwind for Amazon is regulatory scrutiny. Lina Khan, the chairperson of the Federal Trade Commission, has been particularly tough on Amazon with numerous lawsuits. The more prominent you get, the more scrutiny you attract. A case in point is Microsoft's experience with antitrust lawsuits in 2001. Though Microsoft wasn't broken up, it became more conservative and less innovative to avoid government ire. I suspect Amazon has learned from Microsoft's experience.

Amazon has a strong advantage in customer loyalty. Customers genuinely love Amazon, and that's a massive tailwind for them. My wife's reaction to the thought of canceling our Prime membership says it all about their customer obsession.

As to who's the next Amazon, that's a tough question. Amazon's management is excellent, and its distribution network is a significant asset. Despite competition from Chinese companies and smaller e-commerce players, Amazon maintains its lead largely due to its customer obsession. For example, their hassle-free customer service, like the instant refund I received for a product without needing to return it, exemplifies this.

However, it's worth noting that small businesses often feel at odds with Amazon because it tends to favor the customer, sometimes at the supplier's expense. While large companies like IKEA can absorb these costs, smaller businesses cannot, which is where platforms like Shopify come in. Shopify has become a favorite among small businesses who want to avoid Amazon's squeeze and maintain their branding. It's positioned as the go-to platform for those who want to do it on their own, leaving Amazon for larger suppliers and the general retail customer base.

Etsy remains too niche, but Shopify is emerging as a strong competitor, offering a balance for those who want independence and control over their sales and customer interactions. That's right, even after Shopify initially sold a fulfillment company back to Amazon, it has become a crucial tech platform for small businesses. These businesses can't pour vast resources into technology, and that's where Shopify steps in with its robust system, helping them to go online and leverage the internet's power.

Now, about Amazon's valuation — currently at $1.4 trillion with a price-to-sales ratio around 2.3 to 2.4 — the growth is showing signs of slowing. The market valuation, which is what it is at any given point, seems fair. But let's entertain a few scenarios. In a more pessimistic outlook, where growth slows to 2-4% and investments like One Medical don't pay off as expected, the price-to-sales could drop to 2, bringing the valuation down to $1.1 trillion.

Conversely, in an optimistic scenario where Amazon's new ventures in pharmacy, healthcare, and fulfillment scale up — possibly giving UPS and FedEx a run for their money — I can envision Amazon growing into a $3.5 trillion company in the next five years. If their investments plateau because they can't possibly build more warehouses, then free cash flow would likely increase, potentially leading to a higher valuation. Good companies tend to launch a new billion-dollar product every three to five years, and I wouldn't put it past Amazon to continue this trend.

In summary, for those debating whether to invest in Amazon, I lean towards the optimistic scenario. Amazon looks promising as a long-term investment, especially considering its attractive price-to-operating cash flow ratio. If you've been waiting on the sidelines, now doesn't seem like a bad time to buy. And for those invested and worried about Amazon's future — I don't believe Amazon is going anywhere but up in the next decade.

Lastly, if you're looking for more investment ideas, check out Xillion. We conduct thorough analyses to identify high-potential investments and focus on growth rather than stability or dividends. We aim to spotlight companies that might be the giants of tomorrow. You're welcome to explore and get a month free when you sign up on our website.

If there are any questions or further clarifications needed, I'm here to help.


Amazon is at about 2.4... the reason that Amazon is higher is because Amazon is not just a retail company... and also if you look at Google, Netflix, they're tech companies, their price to sales is six and tech companies in general range from 5 to 10.

Amazon's customer obsession is exemplified by the high-value customers place on their services, like Prime membership. A simple yet telling example is the strong customer reaction to the idea of canceling Prime, indicating how integral it has become to their everyday lives.

Amazon has a successful track record of acquiring businesses and integrating them effectively into its ecosystem.

Amazon strategically reinvests its profits into its business to fuel future growth, rather than taking higher immediate profits. Despite this strategy, they are still able to generate substantial profits, like the 11 billion reported, showing the underlying profitability of their business model.
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