One of my readers, Heber, wrote this about Amazon: "I was amazed to find a comment here that Amazon is overpriced. Amazons current EPS is $2.31 Their equity growed 27% last year, over three years at 74% and over five years at 91%. It is slowing down, but it is still way high. According to morningstar.com the analysts expect a 26.6% five year growth. I am using the 27% as an expected growth rate. The current PE is 80, so for the sticker price I am using 54, twice the expected growth. That gives me a sticker price of $336.56, or an MOS price of $168.28 Currently Amazon is selling at $186.13. That is very close to the MOS price and well below the sticker price. I am tempted to buy...."
First, I have to remember that blindly using the analyst's growth rate without looking more deeply can be a problem with our estimates of value. Analysts are often quite optimistic about a company's future growth rate because it encourages those companies to work with the analyst's investment banking group. If you're an analyst you don't want to be the only guy who says bad things. Also they are only looking out 5 years. I have to look much farther than that.
Current earnings are $2.31 per share. If I use Heber's (and the analysts numbers) Amazon must grow those earnings at 27% a year for ten years. If that's right, the earnings in 2021 will be over $25 per share. With a PE of 54, Heber is thinking he can sell for $1361 per share. That will value the business at over $11 trillion.
Remembering that the most valuable business in the world is priced at $400 billion today, isn't that asking a lot from Amazon? But it gets even tougher for this poor company: That estimate of value demands Amazon double the market cap of its 2021 gigantic operation almost twice more to about $40 trillion by 2026.
Amazon is a great company. I think Heber has that part right. It has great management, a huge moat, and its the gorilla in its industry. But price is everything for an investor. It does us no good at all to buy wonderful companies if we pay too much for them. We might as well put our money into a mutual fund where the fund manager does that sort of investing every day.
Granted, Heber is wisely discounting by 50% but these huge future numbers make me think he doesn't have the value, the sticker price, right. If he doesn't have the sticker right, his margin of safety price is an illusion of safety, not the real thing. We really do want the real thing for an MOS. There is so much that can go wrong that we have to try to put a real sticker price on the business, not a sticker that requires the company grow to become the largest business the world has ever seen. (And I'm not saying Amazon can't do it - just that doing so would be unexpected).
Even assuming great growth for Amazon for the next 15 years, say 20% with a 40 PE, my tools say its too expensive. According to the RuleOneTools, it has a sticker today of $141 and an MOS of $70 with an MOS Payback Time of 10 years (see below).
That's bad news for Amazon investors who are looking for a deal. Even if I pay $70, the time it would take me to get my money back from earnings is 10 years. That's a long time. Right at the edge of what's acceptable. As much as I like the business, I can't pay Mr. Market's asking price of $186 and expect a great return for the next ten years. Not unless I expect an even bigger fool to come along and buy it from me later.
If it helps, remember that any obviously great business is likely to be overpriced much of the time. Be patient. Rule #1 depends on it. Wait for Mr. Market to freak out. It happens regularly enough. Buy when there is fear, not when everything is looking pretty good.
Now go play
