The Market Ticker
Commentary on The Capital Markets- Category [Market Musings]

You got to be kidding me.

Amazon Inc. Amazon revealed a profit Thursday, and Wall Street analysts were pleasantly surprised by it. Comments coming from some of them suggest they still don't understand the core philosophy of CEO Jeff Bezos and the way Amazon works. 

AMZN rose 14% on the news, and a whole bunch of analysts welcomed the online retailer's new era of profitability. You can read their comments here and here and here.

They're almost certainly wrong. Amazon is extremely unlikely to suddenly start focusing on earnings per share for investors.

In fact, analysts have a long history of misunderstanding Amazon.

I don't think so.

In fact, I think they understand it perfectly well. I know I do.

What I don't understand is why anyone thinks the common stock of the company is worth a nickel.

A lot of people believe that if a company never makes money, it must, fundamentally, go bankrupt. This isn't the case, as Amazon proves.

Absolutely not.

However, existence isn't a reason to buy stock in a firm.  Remember that when you buy stock you're buying ownership.  And ownership, basically, comes down to two things -- net value and the forward earnings returned to you in dividends.

You can look at the former (net value), if you wish, as book value.  However you need to take that with a (big) grain of salt, because property, plant and equipment is often (nearly always) held on the books at depreciation value, and rarely will the assets of the company fetch anywhere near that -- especially for a technology company -- in a liquidation.  I will note that one of the ways to make a killing as a small businessman is to find someone going out of business and buy their equipment that you can use or repurpose for very small amounts of money compared to it's so-called "book value."

It is, in fact, exactly that approach that, if you're an entrepreneur, can result in a very hard-to-beat cost structure in a competitive marketplace.  That's how you spell "profit", incidentally.

So what else do you have of value when you buy stock in a firm?  The discounted future return of capital to you as a shareholder in the form of dividends.

Here is how Amazon actually works: As long as the company can grow its revenues, it can spend any profit it makes on new lines of business that throw off more revenues. Those revenues may also be profitable, and those profits can in turn be immediately spent again on more growth. By eschewing profits, the company can also offer the lowest prices possible (which is why consumers are so loyal to it). Some parts of the company are profitable and fuel growth in others.

I see.  

The problem with such a strategy is that you're paying a lot for nothing.  Today you're paying about 14x book value for the company, since it never has and never intends to, as you state, pay a dividend or otherwise return any cash to shareholders.  That is, you're "investing" in something that has an actual tangible value that is 1/14th of what you spend on it.

Of course as a customer this doesn't matter a bit.  But as an investor it most-certainly does because the actual value of your "investment" is (materially) less than 10 cents on the dollar.

As a consequence if anything goes wrong that $350 stock is likely to be suddenly worth $30 or thereabouts.

So it doesn't matter if Amazon never makes a dime. In fact, Amazon's history clearly shows that profits are a secondary concern to revenues, as this chart from the Financial Times shows:

It doesn't?

Here's the bottom line: Effectively all of the stock price is nothing more than the belief that a bigger sucker will come along and pay even more times the tangible value of the firm than you did.

As long as that holds true the price continues to go up.

The day it is no longer true because some critical mass of people who own the stock wake up in a cold sweat -- an event that could be prompted by an earnings miss or simply the phase of the moon going the wrong way the price will collapse by more than 90%.

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That's simple -- when the smallest hint of stopping the robbery -- in this case, credit emitted by those with no ability to pay causes said market to collapse by upwards of 7% in a single day.

That's what happened last night in China, and it leads one to ask: Are you really dumb enough to think this is local to China?

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Go read this Ticker again.

Then think on the following:

  • Most of the employment improvement since the 08 crash has been in the energy sector, net-net.  This is particularly true if you look at employment ex-McJobs (low-paying, part-time work.)

  • The S&P 500's energy sector is about 10% of the index.  Those firms are going to miss, and most will miss badly.  A material number of them are likely to have negative earnings (and maybe by a lot in the current and forward quarters.)

  • Saudi Arabia and the UAE have said they will not protect oil prices.  They appear to mean it.  The UAE recently said that our shale and fracking production needs to be "curbed"; the way to do that is to make it uneconomical.  Of course if that causes bankruptcies, well, too damn bad.

  • Most of these firms and the governments in the vicinity of their projects have entered into commitments to spend money that can only be generated by profits and taxes if oil is around $100/bbl.  It's currently less than half that.  Good luck with those plans.

  • Nobody does this sort of spending with cash any more -- they all borrow the money, and most of it has already been borrowed.  Worse, nobody ever bothers to repay borrowings any more -- they just roll it over and increase the amount.  This is going to get very amusing when the cash flow is revealed to be insufficient....

The entire premise of the market has been easy money and more credit leading to financial engineering.

When the backing for that credit turns into a puff of smoke what floor is present under the market?

None!

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