Buffett Makes a Bold Move: Investing in Amazon! Learn the essence of long-term investing that isn’t swayed by PER
Berkshire Hathaway, led by Warren Buffett, has invested in Amazon.com (AMZN).
On May 2, renowned American investor Warren Buffett disclosed in an interview with CNBC that his investment company Berkshire Hathaway has for the first time acquired shares of Amazon.com (AMZN.O).
May 2, 2019 Reuters
Buffett hassaid he “regrets not having invested in Amazon earlier.”Now he has finally taken the plunge into the investment.
Amazon’s PER is 65x! Isn’t that too high…
The issue here is Amazon’s investment metrics.PER is 65x, PBR is 20x. In the common “value investing” framework, this is a price that is hard to buy.
However, Buffett insists that he is not leaving the realm of value investing.I attempted to interpret his reasoning in my own way.
Buffett’s investment approach is to purchase and hold a company at a price cheaper than its “value.”Value is the present value of the cash flows the company will generate in the future, in simple terms, the sum of profits.
Since it is about the future,no one can know it exactly. Therefore, there is no mechanically determinable figure, and estimating value inevitably involves some degree of subjectivity from analysts.
What compensates for this is PER and PBR. They use numbers based on the more certain past or near future, rather than the uncertain future. They are imperfect indicators, but useful starting points for analysis.
A company that doesn’t make profits finally does
However,these indicators can be less meaningful in some cases. For example, growth companies have little current profit, so PER is high. Yet if profits will expand significantly in the future, a high PER may not indicate overvaluation.
Amazon can be viewed in this way. The company is massive, yetfamous for “not making profits”.
Nevertheless, it has recently begun to generate profits gradually.Operating income in 2018 was three times that of 2017.
This is undoubtedly due to theworld’s largest cloud service, AWS.
Cloud computing is a business where, once a company adopts it, switching is difficult (high switching costs),deep moat in economics. It has low variable costs and high contribution margins.
In the digital world, achieving de facto standards is essential to win competition, so AWS’s overwhelming market share may have appeared attractive to Buffett.
For example, if AWS’s expansion makes total profits triple,the current 65x PER would become 22x, and would not be considered expensive. When valuing growth companies, this perspective is also necessary.
Focus on the period profits are produced!
It’s not just the cloud business. The retail business, which currently earns little profit, may have attracted Buffett and Berkshire’s members as well.
Amazon’s dominance in e-commerce is no longer in doubt. In the expanding world of e-commerce, this position is unlikely to be easily overturned.
Businesses that are not easily toppled continue to generate profits over the long term. And since a company’s value is the sum of profits it will generate in the future,the longer the period of profit, the greater the value.
For example,the value of a company that earns 1 billion yen in profit for 10 years is 100 billion yen, but if it lasts 30 years, it becomes 300 billion yen. In other words, the fair PER for the former would be 10, and for the latter 30 (the actual situation is more complex, but this simplification is for explanation).
As long as Amazon remains the leader in e-commerce, the period of profit generation is expected to be long.If the company continues to lead for the next 30 years, the current PER of 65x would not be considered expensive.
In this way,focusing on the period of profit allows investing with an eye toward 20 or 30 years into the future. This is what could be called true long-term investing.
From investing in Amazon, let us learn the essence of long-term investing.
