(This is a reprint of my SeekingAlpha article, which is now behind a pay walled.)
- People who are freaking out about 2Q17 results do not understand what Amazon is all about.
- Higher investment is not bad; it is the opposite of bad – it is fantastic.
- Investors should hope that Amazon could pursue their agenda by spending even more aggressively.
Since Amazon (AMZN) reported 2Q17 earnings on Thursday after the close, I counted 11 Amazon articles on SeekingAlpha. I don’t mean to pile in, but I see confusion and gaping holes among existing analysis that ought to be addressed. My main point is as follows: not only is more spending “not bad”, it is actually very good. The opportunity is so huge that I wish Bezos could have deployed even more capital!
At this point, we all know that Amazon beat revenue in Q2 but missed earnings due to higher investments. They also guided Q3 revenue to in-line while guiding to below consensus earnings due to, again, investments. Amazon bears are more or less saying the same thing, “Look at all those expenses! Bezos is running a non-profit business! The business model doesn’t scale!”
If these bearish arguments sound familiar, that is because they have been around for a long time. I recall 11 years ago, when I was a college student, I listened to a hedge fund manager brag about his AMZN short: “They are running a non-profit business! The bigger they get, the more they lose! How can Amazon be worth so much! Better capitalized competitors will learn and kill them!” At that time, AMZN was trading at under $30 a share, and I was too green to recognize that “smart money” can be wrong – dead wrong.
Fast forward to today, I’m hearing the same arguments. People look at a quarter, or some short term setback, and they immediately pull out that old argument without reflecting on why that argument has not worked since the turn of the century. In the hedge fund industry, we call stocks like AMZN “widow makers” for a good reason – stubborn bears get so fixated on metrics that they think are important that they completely fail to understand what’s happening in the real world, so they short the stock again and again until they jump off a building.
For whatever reason, some analysts do not understand the difference between an expense and an investment. An expense is what you spend to generate revenue today. An investment is a cash outflow today for increased revenues and profitability at some later date. Expensing a cash outflow right away is often associated with expenses, and capitalized cash outflows is frequently associated with investments, but the smart analyst must determine what is an expense and what is an investment without regards to what the optics are like. Generally speaking, unexpected expenses are bad, and – assuming that you trust management’s ability – unexpected investments are good. If Warren Buffett said, “I thought I was going to deploy $20 billion, but an opportunity came up where I can deploy $60 billion”, investors would be ecstatic. (By the way, if you think Bezos is not a business genius or is a fraud and an idiot, then that’s just a fundamental difference that we cannot bridge. If you believe that, go short the stock.)
Very closely related to understanding the difference between an expense and an investment is understanding the difference between “unable to generate a profit” and “unwilling to generate a profit”. I’ve shorted many stocks in my life, and I can tell you that the difference is night and day. Generally speaking, an “unable to generate a profit” companies mislead investors about their competitive advantage and their progress, but in reality, even if they get bigger through acquisitions and tapping the financial markets, their pound for pound competitive advantage decreases over time and can be seen in declining per share equity value. It’s like a guy who wants to “get big” by eating 10 donuts a day – it’s big, just not the “big” that we all have in mind. On the other hand, the best investment opportunities are in companies with such huge opportunities that they keep ploughing everything they got back into the business for years and years and years. That’s how Nike (NKE) did it as Mr. Knight detailed in his fantastic book, Shoe Dog. That’s how Wal-Mart (WMT) did it. That’s how all the great companies did it. When these great companies one day say “We’ve run out of places to invest money so we will focus on cutting costs, buying back shares, increasing our dividend, and diversifying our business through acquisitions”, you get the IBM of today, and you ought to get out of the stock.
Let’s go back to AMZN’s 2Q17 earnings. Was the “earnings miss” due to more expenses or more investments? Let’s look at the earnings press release, in which Bezos clearly stated: “We continue to see many high-quality opportunities to invest.” Let’s move on to AMZN’s conference call, in which the CFO said, “We were very encouraged by the revenue and unit growth acceleration… we’re constantly working on our cost of delivery and our route densities. And again, we like what we see and we’ll continue to expand that and we’ll be working very hard on making that not only a valuable Prime offering, a Prime benefit, but also a lower-cost operation as well…”
It is pretty clear from these comments that AMZN sees strong demand and areas to invest capital productively. Ecommerce, retail and delivery are very capex intensive, and it is clear from my highlighted comments that Amazon is executing its long-time strategy of increasing its competitive advantage by scaling up to drive down costs. If you want more evidence, go listen to the entire 2Q17 earnings call.
If you understand what Amazon is all about, and if you read the press release and listened to the call, it is difficult to view Q2 results as anything but bullish. Bears do not understand that Amazon’s spending are investments rather than expenses, and that Amazon is “unwilling to generate a profit” rather than “unable to generate a profit” because the opportunity is simply too huge to stop growing. Amazon has been a widow maker, and I suspect it will continue to crush bears as it crushes the competition across the retail spectrum.