While reading Jeff Bezos’s letters to shareholders since 1997 until 2018 (I couldn’t stop reading!!!), I started wondering: Had Jeff been into the world of investing, he would have given Warren Buffett (‘WB’ – incidentally, one of the world’s greatest investors) very serious competition.
While WB is known for his allegiance towards investing in brick-and-mortar, old-age easy to understand companies, with enduring moat, credible management at sensible prices; Jeff’s building of Amazon from scratch, (enabling it to become a USD 1 trillion enterprise by market capitalization) adheres to some of the same very principles by which WB swears by.
Below are some of Jeff’s thoughts over the years, which clearly demonstrate his superior investing acumen.
It’s all about the long-term: “While focusing on customers, we have continued to focus and invest for long-term market leadership considerations, rather than focusing on short-term profitability considerations or short-term Wall Street reactions.” WB has also adhered to following an owner of business approach, even when taking minority position in stocks, thereby having a long-term investment holding in the invested companies. In fact, he would NEVER want to sell his stocks (Imagine you being his stock-broker!!)
Focus on Free Cash Flows Vs Profit: “Our ultimate financial measure, and the one we most want to drive over the long-term, is free cash flow per share. Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth? The simple answer is that earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings. Future earnings are a component—but not the only important component – of future cash flow per share. Working capital and capital expenditures are also important, as is future share dilution.”
Since Amazon was not required to build physical stores or stock those stores with inventory, their centralized distribution model allowed them to build business to a billion-dollar sales rate with just USD 30 million in inventory and USD 30 million in net plant and equipment (Year 1998). Operating cash flow of USD 31 million more than offset net fixed asset additions of USD 28 million. Their inventory turns increased from 12x in 2000 to 16x in 2001.
It essentially works on a negative working capital, i.e. other People’s Money (OPM); With money being collected up-front from customers before payment to the suppliers and inventory being turned quickly, it is required to maintain relatively low levels of inventory. In 2004, Amazon invested USD 480 million in inventory on a sales base of USD 7 billion (14.6x)
If one were to keep putting money in savings bank account which yields a meagre savings rate, and which only grows when you put more money; it’s obviously not a good way to make money.
Invert, always Invert: “We’ll start with the customer and work backwards. In our judgment, that is the best way to create shareholder value.”. This maxim holds true in Investing as well and enables someone to relook at propensity of the company to deliver on its key deliverables, if the stock price were to start increasing at a very rapid clip, basis some fairy-tail story, either planted by the management or an illusion of the investors. More on this covered in http://jaagrav.com/index.php/2018/11/11/recommended-by-experts-invert-please/
Commitment and Consistency: Jeff’s principles underlying the business philosophy has remained consistent over the years. Right from having a laser sharp focus on customer centricity to financial metric of maintaining and increasing free cash flow per share, it has never wavered despite during the dot-com bubble in 2000, irrational euphoria of 2004-07 and post-Lehman crisis of 2008.
Bold Bets: “Outsized returns often come from betting against conventional wisdom, and conventional wisdom is usually right. Given a ten percent chance of a 100 times payoff, you should take that bet every time. But you’re still going to be wrong nine times out of ten. We all know that if you swing for the fences, you’re going to strike out a lot, but you’re also going to hit some home runs.”
This is best stated by Charlie Munger, WB’s partner on seeing a good investing opportunity: “We double up when good opportunity knocks”. WB had put more than 40% of the company’s net-worth in a single stock; that is truly bold; very unlike some of the investment thesis of not putting more than 5% or 10% of the investment in a single stock, etc.
Boat is better than the rower: Jeff clearly understood that the company needs to be in an industry which provides enough tail-winds for the company to run successfully. “We’re fortunate to benefit from a business model that is cash-favoured and capital efficient.”
As WB has said that we want to invest in companies, which any fool can run, because one day, a fool will run; Industry tail-winds and dynamics play a huge role in the success of the franchise.
Compounding machine: While WB has continuously been reading for the last 60 years, close to 500 pages per day, compounding his knowledge and thereby utilizing it to put it into investing; In a similar vein, Jeff has gone about building Amazon Web Services (AWS) – one of the world’s largest cloud services enterprise (FYI, it has already clocked in USD 10 billion of revenue), Prime Membership (With millions of subscribers, this number is only swelling up) and Marketplace (network economics @ play wherein millions of buyers and sellers transact using Amazon’s platform) in a span of around 20 years, post its listing.
Small steps, taken one at a time and then betting the farm, when it became reasonably visible that the captioned businesses would scale up is where Amazon has been able to fructify its gains substantially.
Deep Understanding of Customer psyche (Mr. Market in Investing world): While Jeff clearly understands the customer mind-set, which continues to remain his first pillar. This psyche has been harnessed in the truest terms by Amazon. Customers value low prices, vast selection, and fast, convenient delivery and that these needs will remain stable over time. It is difficult for us to imagine that ten years from now, customers will want higher prices, less selection, or slower delivery.”
While Jeff’s understanding of the customer psyche is immaculate, WB’s understanding of market psychology (Mr. Market) is legendary. Cyclicality of markets and the phenomenon of Greed Vs Fear, leading to Mr. Market’s mood swings, right from irrational exuberance to World is coming to an end tomorrow is where WB has made tons of money!!
High-velocity Decision making: According to Jeff, “some of the large companies make high-quality decisions, but they make high-quality decisions slowly. Speed matters in business – plus a high-velocity decision making environment is more fun too.”
Incidentally, WB has taken some big investment decision in less than 5 minutes; it’s like being prepared for the big day and strike it Big, when the opportunity knocks. He is able to deploy vast sums of money, running into billions of dollars very quickly – no term sheets, no investment committee and multiple layers of approval required!!!
To sum it up, after all, a lot of the above is Common Sense, however, someone rightly said – “Common sense is not common to all.”
Disclaimer: Please note that these are my personal views. While, I am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.