I’ve been wanting to put these thoughts down for a while, but am only finally getting to them.
I want to make a modest proposal: stop comparing AMZN to AAPL. In fact, stop comparing AMZN to other firms as a means to belly-ache.
You hear a lot of people moaning and groaning about AAPL’s P/E ratio, especially as it relates to a company like AMZN. As of Friday, the AAPL P/E ratio was around 11.5, while Amazon’s was at an astonishing 3,330. Here’s Matt Yglesias recently on the problem:
But what makes Amazon not just amazing but downright dangerous is that as a financial matter it has something even better than profits—the boundless faith of the investment community.
Along the lines of Yglesias, let’s throw up a P/E graph.
AMZN P/E ratio is astronomically higher now that the company fell into loss this quarter. But the idea is clear here. Arguably a better metric, Enterprise Value/EBITDA shows a similar story.
But if I were to ask you which one of these companies doesn’t belong, which would you choose?
Three of these companies are technology companies. They’re shaded in blue. AMZN is not.
When we try to think about why we even use measurements like P/E and EV/EBITDA, the story really becomes clearer. These are ratios expressing the value of the firm above and beyond the value of the company’s earnings that equity holders are individually entitled to. It is empirically true that firms in similar industries tend to converge at similar P/E ratios over time. The larger firms get, the more difficult it is for them to grow revenue on a percentage basis. Their growth path converges upon a limit and they achieve something of a steady state. In so doing, the market finally assigns them a relatively predictable premium/discount to earnings per share that reflects the firm’s value beyond its earnings. AAPL is undoubtedly the greatest business success story of the 20th century. But it cannot escape P/E destiny, and it is clear from these charts that AAPL is trading at a premium to earnings that is relatively consumate with its industry.
Now, a reasonable argument would be to look at MSFT’s 14+ P/E ratio and say AAPL is being undervalued. That’s more reasonable.
AMZN is a beast that the market is still trying to grapple with. It’s a media Company, so a lot of people want to throw it in with AAPL and MSFT. More importantly, though, AMZN is a retailer. It’s not like AAPL, a retailer of its own products, although it too has a formidable supply chain. In a sense, it’s more than that. You don’t have to like Windows or OSX to shop AMZN. AMZN is rapidly becoming the point through which people primarily source the products they want to consume in life. More importantly, this is a Company that started as a book retailer. It has become so much more.
If your reply is “well AAPL started as a computer manufacturer and now it’s so much more” then you got nothing out of this post. My argument is at turns a bold slap in the face of many people and quite humble. The market is incredibly wise and powerful, and it’s far smarter than people who think every company in the world should plot to the same point on an axis as a requirement of justice.
Investors love AMZN. It is in fact scary for traditional retailers that AMZN can loss-lead its way to global domination. But AMZN doesn’t feel like a Company that should be losing money. That’s because it isn’t actually that kind of Company — and the market is correcting it by pricing it many multiples above its earnings regardless. When AMZN stops loss-leading, which it will have to one day, the market will find an appropriate level for it to trade at. Even then, it might diverge from AAPL because AMZN has competitive touch points with AAPL but is a very different beast. The market knows this. Techies look at the Kindle Fire and are baffled by AMZN’s P/E ratio. Classic case that people are wrong and the market is right.
The market seems to not expect there to ever be another AAPL game-changer like the iphone. No one says the market divines the future, though. There’s just no compelling information now for the market to price that kind of innovation in. If we do have another 2007-like year for AAPL product introductions, then I imagine the market will act swiftly. The great irony is that techies will see this as vindication when in reality it proves nothing except that they had correct intuition when the market rested on hard truth.