Swimming Against the 'River of No Returns' - Vivek Kaul's Diary
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Swimming Against the 'River of No Returns'

May 27, 2017


GUALFIN, ARGENTINA - Yesterday, an amazing storm blew up.

The wind gusted up so much dust, we could barely see 10 feet in front of us. Dark clouds rushed overhead.

Rain...rain!...came down in drops the size of coffee cups. Up in the mountains, light snow covered the peaks.

Cozy Valley

The storm swept in just as we were getting in our pickup to drive down to the lower valley.

We moved on a doctor's suggestion. The 1,000 feet of elevation (not altitude; a dear reader corrected us) makes a difference.

At 8,000 feet above sea level, in our casita near the vineyard, we sleep like a baby. At 9,000 feet, we don't sleep at all.

The main ranch house is on a windblown prairie between two mountain ranges.

This time of year, the wind howls, beginning in the afternoon and continuing through the night.

'The wind blows the air away,' say the locals. It doesn't make much sense. But there might be something to it.

The casita - barely 400 square feet - is in a cozy valley with less wind, less cold, and less dust. You can see a bit of what it looks like through our glass wall.

The view from Bill's casita down in the valley

River of No Returns

Yesterday, we watched our favourite stock - the 'River of No Returns', Amazon.com.

We expected it to close over $1,000. It ended $7 short. The proximate cause of this remarkable run was its latest earnings report. Amazon earned $1.48 per share in the first quarter.

How much should a stock like that be worth?

We've bought a number of businesses over the years; it has almost become routine.

We have a formula we apply to new business acquisitions as well as sales between partners, stakeholders, and other insiders.

Generally, we take the last three years of earnings, average them out, and multiply by four. That's right: four. A retiring partner, for example, may sell his stake back to the company for four times earnings.

'You buy companies for a price-to-earnings [PE] ratio of just four?' we hear you gasp.

Yesterday, Amazon shares traded at 185 times earnings. On average, the large, well-established companies listed on the S&P 500 sell for earnings multiples of 26.

How comes it to be that we can buy companies for just four times earnings? And what is a company really worth...when PE ratios vary from four to 185?

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Public Spectacle

Part of the explanation for the wide gap is the difference between large public companies and small private ones.

The large ones have large public markets; it is easy to buy and sell shares. They are well-researched and regarded as safer than small startups. So pension funds and large investors can buy them.

Also, public companies are part of the public spectacle. They are to the investment world what public information is to the intellectual world. They're in the news. They're mainstream.

It's always better to be conventionally dumb than unconventionally smart. You won't embarrass yourself by being outraged by Trump's budget proposals...or by buying Amazon.

And if you're a professional money manager, it won't damage your career. Everybody knows it's the right thing to do. And now that Amazon's shares have gone up so much, everybody knows they will go up even more.

Here...in Investor's Business Daily...we see the careful, analytical minds at work:

  • Jefferies analyst Brian Fitzgerald hiked his price target on Amazon shares to 1,150 from 975 and maintained a buy rating.

    'In our view, Amazon remains a core e-commerce holding, one of the best large-cap ideas in our coverage universe, with plenty of growth opportunities ahead,' Fitzgerald wrote.

    RBC Capital Markets analyst Mark Mahaney raised his price target on Amazon to 1,100 from 900 and maintained a buy rating.

Investing in private companies, on the other hand, requires private knowledge. You can't do what everybody else does. And you can't think what everybody else thinks.

There is no public research readily available...nor any public opinion to tell you what to make of it. You have to figure it out yourself.

Price Target

In our little niche of the financial publishing business, there are few people willing or able to do the work involved. This leaves sellers with few options.

Also, sellers typically want to get out because they've run into some trouble. Time, money, health issues, divorce. Often, they are well-motivated to sell.

And a knowledgeable buyer may be able to solve those problems and make the business much more successful. A seller often hopes the buyer will be able to make the business worth more...and share the gains with him.

A seller also often retains an interest and becomes a partner. Or he asks for payments staggered over a number of years...based on the same formula...so he can benefit from whatever skill, luck, or money the buyer puts into it.

On the other hand, small companies come with additional risks - especially troubled companies. Records are often poor. Analysis is often incorrect. Management is often missing.

Sometimes, the business model just doesn't work. And a buyer who thinks he can solve these problems is frequently proven wrong.

Of all the companies we've bought over the last 38 years, probably half have failed.

In this light, you may say we paid the equivalent of eight times earnings per successful purchase, which seems more reasonable.

Amazon has been around for more than 20 years. Its management must be decent. There are no secrets in its accounts. It is profitable. It is not likely to fail.

So what's Amazon worth?

Let's apply the formula. Our price target for Amazon: $6 of annual earnings x 8 = $48.

BILL BONNER Founder, Agora Inc

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "Swimming Against the 'River of No Returns'"

Dilip Avadhani

May 28, 2017

Why is there no value given for brand, moat and market share? Amazon demands great value against all 3 parameters and there is no competitor. There has been commentary that Amazon's rise is not sustainable is on for a long time but it has been more than 20 years that Amazon has just about captured everybody's mindspace.

somewhere there is a factor that you have not accounted for , may be.

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