Internet giants like Google and Amazon are more than multinational technology businesses, they are phenomenon that are challenging the rules of investment.
The problem is how do you value a company like Amazon?
Traditional earnings rules go out of the window because Amazon is not a typical business, argues Geir Lode, head of global equities at Hermes Investment Management.
Amazon defies the rules because the company excels on so many fronts. Is the business a retailer or logistics company or technology company?
All and none.
Supreme disruptive business
“The company has changed the way in which we live,” says Lode.
“The Kindle impacted our reading habits, Prime altered the way we shop, and the Echo has started to change the way we manage our homes.
“Amazon has also challenged accepted business practices by offering a retail platform for small third-party suppliers, and by creating a new standard in logistics execution.
“The breadth of Amazon’s operations means it cannot simply be considered a retail business. It is now a global leader in a number of industry sectors.”
He points out that Amazon has goofed along the way – writing off $170 million on the FirePhone flop.
“The sheer scale of the company means these have been absorbed relatively painlessly. All of these factors combine to create expected annual revenue growth of roughly 20%, a healthy balance sheet, and phenomenal market sentiment,” says Lode.
“Although Amazon has unquestionably been successful, the management’s decision to pursue this model has impacted the business’ backward-looking metrics. As previously stated, traditional measures like price-to-book ratio make Amazon look very expensive, but these analyses fail to take into account its future growth potential.
He concludes that to account for potential growth in Amazon’s valuation, Amazon and similar businesses should be valued with a ‘hyper-growth’ model.
“This model allows us to place greater emphasis on forward expectations and market sentiment, and thus more accurately track the likely direction of a business’s share price. Amazon is a textbook example of when applying the ‘hyper-growth’ model achieves a more realistic valuation,” says Lode.