Why Do We Own Amazon.com?

by | Oct 21, 2014 | General

Tremendous sales growth with a growing competitive advantage

Amazon.com is the single biggest force in Internet commerce. The company’s product catalog runs the gamut from diapers to digital media, with new products and services being added all the time. Visionary founder Jeff Bezos continues to expand Amazon’s reach by delivering value and convenience to its customers. 

Characteristics of the Business:

It’s impossible to imagine Amazon.com without the Internet and it’s hard to picture the Internet without Amazon. Billions of dollars worth of retail sales go through Amazon’s servers and large portions of the Internet itself runs on top of Amazon’s Cloud Infrastructure. 

Amazon’s retail operations take a page from Walmart’s “large selection + low prices” business model, but it is taken a step further by running the store through the web. Without the limitation of a physical location, Amazon is able to offer customers a wider array of products than anyone else, enticing customers to do more of their shopping with the e-retailer. 

The business scales remarkably well, and Amazon continues to invest in its web and logistics infrastructure to create a competitive advantage that other companies only dream of having.  Sales continue to grow at a strong pace (over 30% compounded per year over the last 5 years) and the company is positioned to continue growing well into the future. 

Amazon is run in an extremely efficient manner. While investors bemoan Amazon’s lack of bottom line profits, the company generates more & more cash flow each quarter. Bezos invests this cash back into the business at high returns on capital, creating an infrastructure that scales to a level that competitors cannot match.  

The Trend and its Future:

While Amazon already dominates Internet commerce, most retail sales are still done in traditional “brick & mortar” stores. But it’s clear that e-commerce will continue to become a bigger part of overall retail sales and no company is better positioned to take advantage of this trend than Amazon. 

Amazon’s Prime service offers customers two day shipping on most of its products, and it increasingly adds digital content (music, movies and TV shows) at no additional cost beyond the annual $99 subscription fee. 

In many ways, Amazon isn’t just a store, it’s a platform that allows other companies to benefit from Amazon infrastructure. 

In order to service Amazon’s millions of customers, the company had to invest heavily in its computing infrastructure to run the website and the store itself. The company had the foresight to rent its extra computing capacity at low prices. As a result, the Amazon Web Services has enabled Internet services like Netflix, Airbnb, Pinterest and Spotify to scale their businesses at greatly reduced costs. 

Amazon has increasingly allowed third party retailers to sell products along side Amazon’s listings.  This “agency” business model is very profitable for Amazon, as the company collects a percentage of each sale.  Since Amazon only books the fee as revenue, it’s clear that Amazon is responsible for even more than the $90B in sales expected for 2014. 

Key Risks to Watch:

For any retailer, a recession is a major risk and Amazon’s growth would undoubtedly be harmed by recession. 

Google has been rumored to offer a shopping service and Google can’t be happy that customers increasingly go straight to Amazon to search for products.  Alibaba has ambitions to become a major e-commerce company around the globe. 

Investors may become impatient with Amazon’s decision to focus on growing revenues and not increasing returns to shareholders.  This can make the company difficult to value, since the P/E ratio isn’t based on much at all. 

We think Amazon will continue to grow well into the future. Patient, long term investors should benefit from Amazon’s increasing scale and eventually that will fall to the bottom line. 

Best regards,

Evan McGoff


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