When is Less, More? …Revisited
(or Will "Whole Paycheck" become "Half Paycheck")
In December 2015, we penned an article titled "When is Less, More?...Value in Perspective." In light of the recent news that Amazon intends to acquire Whole Foods Markets, Inc. for nearly $14 billion, we thought it was an appropriate time to revisit our observations and examine what has transpired over the past year and a half.
Economic and market highlights over the last 18 months include the Federal Reserve's FOMC raising the overnight Fed Funds Rate 1% (four, ¼% rate hikes), continued economic expansion, profit growth and a few unexpected election results around the world. Slow and steady growth in the US economy continues to build confidence as the depths of the recession 8+ years ago, fade. The evidence that supports this notion is in GDP increases, steady employment gains and improvements in additional leading economic indicators. Conspicuously absent during the current cycle is the presence of any meaningful inflation. This fact has led one of the 12 voting members of the FOMC to vote against raising rates at its most recent meeting. Productivity enhancements seem to provide the most plausible reason as to why the US economy is not experiencing greater inflation at this point in the economic cycle.
At the end of 2015, we performed a simple financial and stock performance comparison of Amazon to nine leading companies. The companies included Southwest Airlines, Adidas, Marriott International, CBS, Digital Reality, Costco, Rackspace Hosting, UPS and Norfolk Southern. These companies were chosen because they are either suppliers or competitors to Amazon and are recognizable consumer brands. We noted that Amazon sported a market value of approximately $320 billion based on a share price of $675. For that same amount of money, one could have purchased a share of each of the nine companies listed above. The combined market value of those companies was just under $300 billion (a better value at the time). Amazon sales over the previous 12 months were $100 billion and terrific growth prospects were abound. The combined sales of the other nine were $250 billion. Amazon had virtually no reportable earnings (by choice) and produced a mere $5 billion in operating cash flow. This compared to approximately $14 billion in earnings and $27 billion in operating-cash flow from the group of nine. Amazon has never paid a dividend or returned any capital to its shareholders. In 2015, a share in the nine other companies distributed nearly $17 in dividends which does not include cash that was used to buy back shares.
So, what has happened since?
Examining the comparison today, Amazon's share price recently surpassed $1,000 for a 45% return since December 1, 2015 through June 15, 2017. The company is worth $470 billion. Other relative statistics over the last 4 quarters include $143B (+40%) in revenue, $2.4B in profits and operating cash flow of $12B (+140%).
The relevant figures for the group of nine include a 41% total return; $365 billion (+40%) in market value; $270 billion in sales (+8%); $13.6 billion in profit and $29 billion in operating cash flow. In addition, one would have received more than $20 in cash dividends. For this simple analysis, we note that Rack Space, the smallest company within the group of nine and the one with the lowest share price, was acquired in November 2016 for cash.
This simple analysis supports the concept that over the past five years, two factors, growth and momentum, have been prized characteristics within the market. Investors have been willing to 'pay up' for these attributes, rewarding investors willing to accept greater risk. Amazon, along with its buddies Facebook, Google, Apple, Microsoft and Netflix, all possess the two factors above and have lead the U.S. equity market averages to record highs.
At some point, valuation based on traditional operating results should matter and one of two outcomes is likely to occur: Amazon continues to grow far faster than the economy as a whole or its valuation shrinks to a level more in line with the broad market as it becomes more like the market. The latter is the most relevant and most difficult to predict.
The market has initially praised the purchase of Whole Foods Market by Amazon and suspects that with a lower cost of capital and technology advantages, Amazon will improve operating results, creating synergies in the grocery business and solidifying the benefits the company receives from the network effect. However, the grocery industry is notoriously difficult and one with razor thin margins. The winners, in time, should be the consumer, but to assume that mass retailers such as Target, Walmart and Costco, not to mention the numerous community and regional grocers, are going to lose their current customer share to Amazon is no foregone conclusion.
There are no bad assets, only assets at bad prices, and markets do not care what one pays for an asset or what they are 'worth.' Markets are rational, over the long-term, and determined by buyers and sellers at the margin. When sentiment changes, prices usually react quickly. Pricing almost always reverts to a value based upon fundamentals. This is why we prefer investments rooted in attractive fundamentals.
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Thank you for reading to the end and, as always, contact us to continue the conversation.