First of all, I would like to talk about my valuation process. The due diligence analysis process is listed below. Once the target stock is selected based on the Net Present Value. Then, the strategy is to understand past, present, and future financial performance. Finally, the big picture which indicates macroeconomics will shed a light on the overall market emotion.
- Target:
Net Present Value (NPV) is the first step to picking up the target company with a bargain value at the moment. - Past:
Based on Buffet’s durable competitive theory, the ratio analysis is suggested across 10 years period. - Present:
The stock price fluctuation is influenced by the current quarterly report. Thus, the year-to-year quarterly comparison is essential to understand what is the status quo of Mr. Market. - Future:
Potential growth analysis and risk analysis are taken into account. For instance, there are some analysis reports revealing the potential risk. Another key factor is management performance. It can be qualified in their annual guideline. Investors can evaluate how accurate their predictions and pathway to success were in the past. - Big Picture:
Macroeconomics should be taken into consideration for the overall market pathway expectation.
1. Target:
The selection method I use is NPV. The setting is like in a textbook quite normal: IRR is 15%; the timespan is 10 years; the present value is with an 80% safety factor. The process is to compute NPV on each S&P 500 company. If the current price is lower than the present value, then it refers to a good bargain for investors.
For instance, Amazon's current price is lower than safety present value. It refers to a buy suggestion. In the following sections, we will have due diligence analysis to answer whether Amazon is really a good bargain.
2. Past:
Based on Buffet’s durable competitive theory, the ratio analysis is suggested across 10 years period. Although past performance cannot forecast the future, it can tell us the reputation early on.
Risk Analysis
- Interest Expense Rate = Interest Expense / Operating Income
Buffet suggests interest expense rate should be less than 0.15 across 10 years. As we can see in the Amazon bar chart, it passes the threshold across 10 years. Moreover, Amazon requested more debt in 2020 and 2021. It has a sign of more investment in the future.
Earning Power
- Profit Margin
Buffet suggests the ratio between total-net sales and net income should be between 10% and 20%. However, Amazon has less than 10% across 10 years. It refers that Amazon’s gross margin is not significant but it is getting better due to AWS’s contribution which provides high earning power.
- Earning per share
Earning per share is a worldwide financial indicator. The suggestion from Buffet is that it should surge as time goes by across 10 years. As in the earning per share bar chart since 2018, the number is skyrocketing from 6.32 in 2017 to 20.68 in 2018. It continues the momentum afterward around a 1.5 to 2 times annual increase.
3. Present
Based on Amazon’s quarterly report, some indicators given in the reports can show the current status of its financial performance. In the quarterly report, Amazon addresses cash flow and operating income for each segment, i.e, North America, International, and AWS. Thus, let’s dive deeper into those concerned indicators to grasp some insights into Amazon’s status quo.
Operating income for each segment
Operating income frankly tells us the most important segment is AWS. It consists of 75% total operating income. As we can see, operating income increases from 4.8B to 5.4B (12.5% upwards). In the following sections, AWS will be explicitly drilled down to find the insight.
Operating income for the AWS segment
Compared to the previous year-to-year operating income, AWS has a promising future without any doubt. However, quarterly AWS performance is decreasing. It is a warning sign of future profit. Moreover, the recession atmosphere is overwhelming in the market. Thus, the decreasing tendency may be temporary, but investors should be aware of the upcoming fiscal year report.
Free cash flow
According to the free cash flow, they are negative in 2022. In Q3 2022 call, an analyst asked how does it happen. CFO told it is due to the bottleneck of the supply chain. As long as the inventory is resolved and Capex reduces in the upcoming season, the recovered free cash flow will be invested to boost the AWS segment. In other words, if the supply chain is not the issue anymore, the free cash flow will be positive like in 2021 and be invested in the promising AWS segment.
4. Future
Based on the AWS segment ratio of operating income and AWS market share, the growth prediction can be simply calculated by an extrapolation method. Here are the resources for the current number of AWS operating income and AWS market share.
- AWS Operating income ratio is 75% in 2021 ((7271M–924M) / 24879M)
- AWS cloud market share is 34% in Q3 2022
Therefore, the extrapolation of growth prediction can be captured from the AWS news. In this way, investors can prioritize the important news that will influence future earnings. Furthermore, All of the news can provide a simulated outline of the total growth of the cloud market.
- Google, Oracle, Amazon And Microsoft Jointly Win US DoD Cloud Contract Worth $9B
– Growth Prediction: 42% = 9B / 5.4B(AWS Operating income in 2021) * 34%(cloud market share) * 75%(Operating income ratio) - Multi-access edge computing spend to reach $23 billion globally by 2027
– Growth Prediction: 110% = 23B / 5.4B(AWS Operating income in 2021) * 34%(cloud market share) * 75%(Operating income ratio) - Global cloud services spend up 33% to hit $62.3 billion in Q2 2022
– Growth Prediction: 8% = 33% * 34%(cloud market share) * 75%(Operating income ratio)
5. Big Picture:
This section is independent of the Amazon stock. I will post it in a different article.
Summary:
Amazon has a bargain price currently below present value. Moreover, Amazon is a durable competitive company based on past analysis across 10 years. In the present analysis, the quarterly free cash flow is not as promising as in 2021. However, the AWS segment is still very strong in a year-to-year comparison. In future analysis, the cloud market shows a 110% of growth rate in 2027. Moreover, simply based on the U.S. Department of Defense cloud investment, my basic extrapolation shows a 42% growth rate. All in all, Amazon is still a moat for investors to seize the opportunity when the price plunges by the fear of recession.
