🏆💸 A case study of a mega-compounder: Amazon

This is a series of case studies on mega-compounders. By studying these mega-compounders, I hope to identify potential long-term high-quality compounders that will be multi-baggers.

I take a different perspective with their years of financial performance and accompanying financial metrics. There is a lot of information publicly available about Amazon, detailed quarter-to-quarter analysis and strategies discussion that I do not want to replicate.

The exhibits below show Amazon’s financial performance from 1995 to 2021 where Amazon grows from USD 0.5m in 1995 to USD 470b in 2021. 

Traces of greatness: 

  • Very consistently high revenue growth; only 3 out of 26 years had less than 20% growth rate
  • Consistently high gross margin growth with only 2021 having less than 20% 
  • Increasing gross margin from 20+% to more than 30% from 2015
  • Marketing costs as a percentage of revenue have been reduced; demonstrating the strength of the Amazon brand.
  • Fulfilment and Research and Development costs as a percentage of revenue have been increasing. Amazon is still reinvesting to be more vertically integrated into its supply chain.
  • Mostly in net cash position
  • Always having a positive operating cash flows

Starting as an online book retailer, it transformed the platform to sell more stuff (digital and physical) by improving the fulfilment infrastructure as well as its cloud computing (AWS). It still remains a much-feared disruptor.

In the case of Amazon, many looking at their very consistent revenue growth with increasing margins over the last 27 years may have mistaken that it had been a “peaceful” period with no crises or challenges (such as the dot-com bubble burst, 2008 Great Financial Crisis, US-China trade wars, Covid) and they have been “perfect” with no failures and no hiccups. It is indeed a remarkable performance that Amazon has been able to grow so well regardless of the situation.
Litmus test: Are we able to identify macro and internal challenges from the companies’ financial statements?

As companies report their earnings every 3 months, we tend to focus on their quarterly performance and their ability to beat earnings expectations and raise guidance. This can make us too focused on the short term and neglect their longer-term performance which should be the key focus for investing in growth companies.

Amazon flywheel first sketched out on a napkin by Jeff Bezos

High revenue growth with increasing gross margins creates solid operating leverage. It creates cash flows for Amazon to reinvest. Over time, their reinvestment builds a faster and gigantic flywheel effect that keeps widening its competitive moat. Looking back, we may not know exactly their investment roadmap. The company is also secretive in their plan. They hide their AWS business for many quarters until it was so big that they had to list it as a business segment a part of statutory requirements.

Its 1997 Letter to Shareholders which has been attached to all subsequent Annual Reports is worth reading. Here is the extract:

It’s All About the Long Term
We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position. The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on
invested capital.

Our decisions have consistently reflected this focus. We first measure ourselves in terms of the metrics most indicative of our market leadership: customer and revenue growth, the degree to which our customers continue to purchase from us on a repeat basis, and the strength of our brand. We have invested and will continue to invest aggressively to expand and leverage our customer base, brand, and infrastructure as we move to establish an
enduring franchise.

Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than
some companies

It explained its long-term, strategic and bold investment approach in its relentless focus on customers than short-term profitability that it has held true to this day. Its relentless ability to reinvest and achieve such compounding growth over 27 years is highly remarkable. Many competitors have been disrupted or fallen behind. Because it keeps reinvesting, its net income margins have been fluctuating between low and negative. Hence, using net income to value Amazon will make it expensive and unattractive.

Being a publicly listed company, it is a tough act to follow to think and work in years and decades allowing continuous aggressive investments and occasional failures for long-term value creation while sacrificing short-term sub-optimal profitability, dividends and share buybacks. Investors and the Board may not have the patience and confidence to wait for years for the investments and strategy to reap the returns, especially during down market cycles. It is also a distraction to employees with a huge percentage of their compensation tied to the company’s stocks.

Books that detail Amazon’s growth:
Working Backwards: Insights, Stories, and Secrets from Inside Amazon by Colin Bryar, Bill Carr 
Amazon Unbound: Jeff Bezos and the Invention of a Global Empire by Brad Stone 

Check out:
Multi-baggers with growth companies
The section on Multi-baggers for other investing ideas

No great companies are obvious when they first started. The financial performances of more aggressive growth companies will not tick most of the boxes on many investors’ checklists, unlike well-established companies. Their financials can look ugly financially.

Credit: BCG, Morgan Stanley Research

The signs of a multi-bagger:

  1. Consistent annual revenue growth of at least 20%
  2. Maintain or better, increase gross margins as it grows its revenue
  3. Generate increasing free cash flow to fund their investment and growth to widen its moat
  4. Grow operating and net margins over time
  5. Improved ROE and ROIC over time