Security Valuation: What Can Microsoft and Walmart Teach Us about Amazon?

by William Smead, Smead Capital Management

While most investors and the media consider the merits of Amazon’s workplace environment, we at Smead Capital Management would like to think about the purpose of owning a business and how today’s stock market chooses to price securities. In our case, we choose to analyze companies as if we were buying the whole business at current quotes, not just a small part. We think about Amazon the way we think about all companies—being the receiver of the future profits and free-cash flows.

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We study business models and reflect on them in relation to our eight criteria for stock selection. We appreciate the technological simplicity of Amazon’s website and their high customer satisfaction. It meets an economic need, the first of our eight criteria for stock selection. Also, Amazon has created huge wealth in stock price appreciation over its life as a public company. So does this make for a meritorious investment to value investors like us?

To understand how we think about securities and Amazon (AMZN) in particular, we will look back at the profits and free-cash flow of Microsoft (MSFT) in its first 14 years as a public company and the sales and profits of Walmart (WMT) from 1980 to 1994. We chose these time periods because they included some of their fastest revenue growth as public companies. Additionally, we like the comparison because Amazon is both a massive retailer and a big technology organization. The attraction Amazon’s common shares have in the stock market comes from rapid sales growth and a low price-to-sales ratio. Rapid sales growth is scarce today and Amazon’s sales success exists in an economy that has had a hard time producing sales growth the last five years.

Here are the numbers:

WMT
Rev + Income 1980: $1.258bn / $41 mil
Rev + Income 1994: $67.345bn / $2.333bn

MSFT
Rev + Income 1986: $198 mil / $39 mil
Rev + Income + FCF 2000: $22.956bn / $9.421bn / $10.547bn

AMZN
Rev + Income 2000: $2.762bn / -$1.411 Bn
Rev + Income + FCF 2014: $88.988bn / -$241 mil / $1.949 bn

*All income numbers are GAAP
Source: Bloomberg

Walmart grew its sales more than fifty-fold in 14 years and turned an operating profit of $2.3 billion in 1994. In defense of Amazon, Walmart didn’t have positive free-cash flow until 1998, as store openings caused capital expenditures to be very high during its heaviest growth phase. However, Amazon reported an operating loss of $241 million last year (2014) with $1.9 billion in free-cash flow on nearly $89 billion of revenue.

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About the author

William Smead

Chief Executive Officer/Chief Investment Officer

Whitman College, B.A. Economics 1980

William is the founder of Smead Capital Management, where he oversees all activities of the firm. As Chief Investment Officer, he is the final decision-maker for all investment and portfolio decisions as well as reviewing the implementation of those decisions in the firm’s separate accounts and mutual funds.

William began his career in the investment business with Drexel Burnham Lambert in 1980. He left Drexel Burham Lambert in 1989 as First Vice President/Assistant Manager and joined Oppenheimer & Co., where he stayed until joining Smith Barney in 1990. William remained at Smith Barney until September 2001 when he joined Wachovia Securities becoming the Managing Director/Portfolio Manager of Smead Investment Group of Wachovia Securities. In 2007, William left Wachovia Securities to found Smead Capital Management.

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