costco returns

Costco operates mainly in the US, Canada, the UK, Mexico, Japan, and Korea. It had $129 b revenues for (August) 2017, of which $94 b came from the US operations, and $19 b came from Canada. That's about 12% coming from its international operations. So it has some headway for growth out there. But will it fructify? 

Costco is a pretty straightforward business in wholesale and retail of merchandise. W. Craig Jelinek has been the President and CEO since 2012. In 2012, the market value of equity was $42 b (high) and now it is $81 b. A double in five years is nearly a 15% return; not bad. Earnings per share increased from $3.95 to $6.13. Expansion in the PE multiple from 25 to 30 was another reason. A 9% annual increase in EPS lead to nearly 15% in market value in five years. If you had picked the stock when the market capitalization was $34 b (low) in 2012, the returns would have been even better. Operating earnings increased from $2.7 b to $4.11 b; that's 8.30% annual increase.

In the meantime, the number of shares outstanding increased from 432 m to 437 m. Almost 17 m increase came from exercise of options and restricted stock units. To offset that Costco operated buybacks of 13 m shares. Had it not done that, the EPS in 2017 would have been $5.95 in 2017. In fact, Costco has been buying back its shares for long. In 2007 itself, it repurchased 36 m shares; then in 2008, 14 m more. From 2007 to 2017, Costco bought back 90 m shares. If shares were not repurchased, the total number of shares outstanding would have been 527 m, and that would have brought EPS down to $5.08. With the current multiple, the share price would be 18% lower at $152 instead of $186 now. Yet, due to higher number of shares outstanding, the market value of equity would be surprisingly similar to what it is now ($80 b). Of course, Costco would have retained cash of nearly $6 b assuming the buybacks were carried at low prices of each year, or it could have distributed to the shareholders.

So were those buybacks really worth it? To perform buyback, you need two factors: Excess cash, and low share prices compared to the intrinsic value. 

Where will Costco go from here? Revenues increased just over 5% annually during the last five years, and just over 7% during ten years. Assuming 7% increase in the next decade, we have revenues at year 10 of $254 b. With the current operating margins of 3.19% and net margin of 2.08%, Costco's EBIT would be $8 b and net earnings would be $5.3 b. Assuming no further dilution in equity, to get an annual return of say, 7%, the stock would need a PE multiple of, obviously, 30 at year 10. That is a rather rich pricing. When we use a multiple of 25, the rate of return would be 4.91%; at 20, the return would be 2.60%. When dividends are included, those returns would be 8.06%, 6.08%, and 3.90%. Well, why should Costco trade at a multiple of 30 or even 25, why not 20? Then there is dilution due to restricted stock units program.

When I do an intrinsic valuation of Costco based upon its free cash flows for the next decade and using a stable growth rate thereafter, I find that Costco is a 6% stock. I also converted its lease obligations into debt ($2.3 b) for the purpose of this valuation. But then for similar growth rates, the market has rewarded its shareholders nearly 15% return in the past. You can never tell what's with the markets.

Where is growth in revenues, earnings and cash flows going to come from for Costco? I think both Costco and Walmart should have some strategy to tackle the onslaught from Amazon. Online retail is here to stay and grow. 

stock market riches

Business profits
I have an acquaintance, who has a small business in a small town. He has been running the business for long. It is a profitable operation, and most of the profits are reinvested back into the business. When asked about his investments outside of his business, he brushes aside and says that it is not much. He does not invest in properties, be it plots of land, which is a common investment theme in small towns, or houses and apartments. He does throw some cash into bank deposits regularly, but that's about it. He has a rather lavish lifestyle compared to his friends in that town. There are lots of leisurely travel across the country, and then some foreign trips too. He likes to eat, whenever his family does, in higher quality restaurants, and according to his friends, he does not hesitate to pay up for his lifestyle. Yet, when you ask him the question, he says that it is just fine and that he does not find anything lavish about it. So how does he fund his life? Obviously from his business. There are drawings from his profits, which are called dividends in public markets. 

Highly concentrated

The way I see it is that he is a highly concentrated investor, who has invested almost all of his wealth in one asset, which is a profitable business. He knows much about the business, its long term prospects, competitive advantages, and so forth. We can talk about diversification, etc. But the fact is that he has been doing what he is doing for very long. He has made money, is reasonably rich, at least in terms of being able to fund his lifestyle through retirement. Who is going to teach him about investing? You don't have to do it the way he is doing. You can diversify your investments more reasonably. 

Businesses need time 
The key point is that in order to make money in business, you have to be in the business for long. You cannot start a business today, and then ask to become rich instantly. The business will have to face both good times and bad times more than once. There wouldn't be linear profits all through. It will begin as a startup, it will grow, it will mature, and probably, it will collapse when time comes. It is true for a private business and also for a publicly traded business.

Investing in businesses
If you want to make money in business, you have two options: One, start a business that will be good enough to grow and feed your long term requirements. Two, invest in a business started by someone else. Not everyone is capable of starting a business and seeing through its growth. It is tough to deal with the competition, regulation, and the macro. You have to be good at investing, financing, and dividend decisions of the business. 

The second option is available to most of us, which if carried out diligently has prospects of enormous wealth creation. This can be done through investments in private businesses or in publicly traded businesses. 

Stock markets are an investor's paradise
Now to the purpose of this post. A stock market is nothing but a collection of businesses, which are rated and priced every moment of trading hours. How can we profit from stock markets? I reckon, there isn't a better place than stock market to make money. These markets are a blessing to most of the lay people, who are otherwise incapable of starting out in a business of their own. Equity markets give that opportunity. 

Unfortunately, though, people look at the stock market as a casino. They throw cash at the stock tickers and expect them to throw back more cash instantly. Their time period is immediate. Stocks are tracked on a quarterly basis; a bad quarter, the prices fall, and vice versa. Every day is like a roller coaster, where prices go up or down, or go up and down. No one knows for sure the real worth of the stock, nor does anyone care. Prices are set based upon perceptions, whims and fancies.

A stock is a business
A stock has a business behind it; and it is a real business. The business has earnings and cash flows. Ideally, stock prices should reflect the value backed by the fundamentals of the business: cash flows, growth, and risk. But they don't as we just saw. Nonetheless, over the long term, they do march towards the true value of the business. For instance, if the business generates high cash flows, compared to the capital invested (return on capital), consistently for a long period of time, the markets will eventually recognize the true value of the business and set the price accordingly. The same will be true for a bad business; there can be mispricing during the short term; but eventually, the markets will have to see poor cash flows and price the stock based upon that.

Of course, there are many ways to make money from stock markets. There are traders, who have been making a living buying and selling frequently. There are investors, who take short positions on bad businesses and make money. There are those who have been able to profit from corporate restructuring such as mergers and acquisitions, spin offs; risk arbitrage. There is more than one approach to riches.

We want a low-stress, low-risk, high-return strategy
Yet the way I see it is, there is no other way that is less stressful than going long on stocks backed by good businesses. If you are able to pick pieces (stocks) of good businesses at the right price, and hold them for long, there are three things likely: One, no stress of trading moments or of quarterly juggles. It's a virtually no-stress investment strategy. You will have time for fun in life. Two, it's also a virtually no-risk investment strategy. Because your investment period is a long time, a decade or longer, the effect of short term volatility in stock prices is nullified. The chances of permanent loss of capital or of earning inadequate returns are brought down to very low. Three, the probability of making more than adequate returns from investments will be very high. This happens for three reasons: Participation in a good business for a long time; Extremely low trading costs since there aren't frequent buys and sells; and Prices paid for the stocks are generally low compared to the growth prospects. 

The probability of low stress, low risk, and high returns shapes up nicely because you are giving time for the business to run the way it should be, and because of that you earn business profits, not market profits. And when the business is good, its profits are almost always good. Remember, you are a partner in that business entitled to your share of its profits. Handing cash to a few chosen, trustworthy business managers is a better game to play than running one business of your own; this is true at least for most people. Five to fifteen handpicked businesses should be able to meet your expectations. A manager, who also has a substantial stake in the business is always more trustworthy (other factors being taken care of) because the skin in the game makes it more dependable. And you can rest assured relax and have fun in life.. 

If you are the owner of say, a private restaurant, would you expect to realize profits within a year, and then sell it off to someone willing to pay you more than your invested capital? Sounds absurd, right? You started the restaurant because you wanted to be in food business that you expect to do well and earn profits year after year. It amazes me, and I wonder why people are so hesitant towards their stock pickings. Stocks too are investments in businesses, albeit in small proportions. So what? A minority share in a publicly traded business is no different from a minority share in a private business. 

Choose the right business, and play long
The moral of the story is that if you are wise enough to pick stocks that are backed by businesses having long term competitive advantages and operated by able managers, who understand where to invest, how to finance investments, and when to payback to the owners, you have a high probability that you will make decent money over the period. A low price for the stocks comes in handy. Because good businesses are often priced very high by the markets, it will be prudent to wait for the right opportunity. And opportunities to pick stocks of good businesses at the right price galore in public markets. 

Time is your friend in this game; show patience
Just show intelligence to identify good businesses, wisdom to buy them at the right price, and patience to hold them for long, and you will be able to show a pile of cash. Patience is a virtue. Making money off inefficient markets is more behavioral than intelligence.

the bitcoin puzzle

Bitcoin is a cryptocurrency and worldwide payment system. It is the first decentralized digital currency as the system works without a central repository or a single administrator. Bitcoins are created as a reward for a process known as mining. I have not come up with this definition. 

Since it is accepted as a medium of exchange by a fair number of buyers and sellers of products and services, and is being considered as a store of value too, it is a type of currency. I am not too sure if it is a legal tender though. Who's backing bitcoins? Where's the promise to hold it as a valid medium of payment under the legal system for meeting financial obligations? Bitcoins are not issued by the government of any country. Sure, it is a type of digital currency, because it is not a physical currency. 

All major currencies are traded on the foreign currency exchanges. Bitcoins too are being traded on the digital currency exchanges. What's the big deal about it? That its price reached $10000 recently? Yeah, it is a big deal. 

From nowhere the price soars to $10000 within no time. It actually has become everyone's envy. If only one had bought it in April 2011 when it was priced $1, or in June 2013 when it was $100, or in November 2015 when it was $500, or when, heck, one could go on. Little does one realize that envy does not take us anywhere; it only puts us down. 

You can see the levels of greed and envy from bitcoin's price history. Yet, for those who are eternally greedy and envious, there's no need to be disheartened; the price of bitcoin is only going to go up, for $40000 price is very near as per this prediction. Volumes are going up, and prices are going up. Everyone is happy.

No, not everyone is happy; we just noted earlier that those who did not buy it are not happy. But they too can be happy if they bought at $10000 and are able to see $40000. Bitcoins are happiness quotients, aren't they?

I am not bothered by the surge in bitcoin prices. People trade in all sorts of things in life, from wood, shoes, and paintings to currencies, oil, gold, and other commodities. They trade in bonds and stocks too. These are the traders' paradise. Speculation is fine if people know that they are speculating. The tragedy though is that most do not know that they are speculating the prices of things they trade. They think that they are buying (or selling) something that has a fundamental value which is going to go up (or down). And this is a dangerous psyche; a recipe for disaster. 

Only assets that throwout cash can be valued. For instance, real properties, bonds, and stocks. Obviously then assets that do not bear cash flows cannot be valued. For instance, gold, silver, and currencies. They can be traded and priced. The price is then purely based upon demand and supply. And demand and supply are clearly based upon the traders' perceptions. They are not backed by the intrinsic characteristics of the underlying asset. For instance, prices of stocks are of course defined by the movements in demand and supply. But demand and supply are based upon the quality of the business behind the stock. That means, when the business does well, the prices go up, and vice versa. That is true on a scale of long periods of time. However, there is no such scale for assets that do not have any underlying (and cash flows). Their  prices move on whims of speculators. Nothing wrong, but nothing much for someone in the right mind, who wants to make money on a probabilistic note.

Now, bitcoins do not have any cash flows associated with them. There isn't any business or an asset behind it. In such cases, how do we know the intrinsic value of bitcoins? Well, we cannot. We are then dependent upon someone else's perception. One fool buys in the hope that there will be another fool to buy at a higher price. The second fool is in the hope to sell to another for profit. And it goes on...until there aren't any fools around to buy. This is when we say that the bubble has burst. The greater fool's theory is an interesting one, for it has been witnessed in the past many times, but lessons are never learned. There's also a reason for that. The early fools usually get away with substantial profits; and everyone wants to be the early fool during every bubble in the making. 

If one of the sharpest minds we have seen could not control greed and envy, how could lesser mortals make do with it?

I have been talked to in the past few months to buy into bitcoins. I resisted like I always do when it comes to speculation; I am no good at it. When you are likely to fret over things, you rather stay away. In fact, I am not even sure if bitcoin is able to sustain as a store of value for long; to that extent it might even fail the currency test.

If your neighbor is driving a fancier car, and you fret over it, there's something wrong with you. And if you chase the neighbor's car, there's seriously something wrong with you. The earlier you realize this, the happier you will be. 

What I know for sure is this: there is an easier route to riches, rather to being financially independent. That is to play the investing game, for long. You could do index investing, or you could do the business of investing. There's a choice. 

Let the bitcoins be. 

money managers, greedy or cheats

I don't like money managers, and I have made it clear more than once. They are the biggest shitheads for what they do. Consider this: asking for money from other people in the pretext of making them rich, is some kind of a sham. The motive is clearly to make themselves rich. And why would they do it? Perverted incentives, I reckon. This is true with all of them, who managed money for others by taking money from them. It is true with those, who continue to do that, and who intend to do it. I know that is harsh, but, I mean it. Their incentives are so misaligned that investors just do not understand it, or prefer to ignore it. 

Before we dwell into what these idiots engage in, let's find out why individual investors hand their cash to others. Investors are either too busy with their affairs that they don't get time to do it on their own, or they are ignorant about investing in general. That makes it easier for them to just pass it across to the so-called experts to do the job. That is understandable. Yet, there is a better way out for them; and this they do not understand. 

We invest because we want to retain, or rather increase our purchasing power in future. We need to be compensated for inflation. We need to be compensated for facing uncertainties of time. We need enough stash to take care of our future requirements. Among all available opportunities, equities have proven to be best suited to play this game. So we need to invest enough in equities in order to have enough in future. 

Here come money managers: mutual funds, hedge funds, alternative investment funds, and you-name-it funds. You have private portfolio managers. There are those, who manage money for only few groups of people. A number of small-time individual money managers have sprung up calling themselves (value, what else?) investors, who are capable of beating all others. Then there are some combinations of sort. What is common among them is that all of them seek money from others in the pretext of making them rich. Let's collectively call them money managers, although I prefer some other name.

There are two types of money managers: Those who generate excess returns consistently, and those who do not. Excess returns are possible when they beat the market returns over a long period of time. Not many are able to play this game well enough. By virtue of their doing, they are either greedy, or cheats. Yet, both types are frauds. Here's why:

The greedy

Let's take money managers, who are good at the game, and therefore, their operations are able to achieve consistent, superior returns over a long period. Their pitch is the precursor; that they promise to generate higher returns for investors. But if we invert, we get a different motive. These managers want to get rich quickly. These are the greedy breeds. Consider this: If someone is good at investing, the best one could do is to start one's own investment operations, which involves investing own money, and build wealth. Over a period of time, because of the superior investing skills, the investment returns would be superior, and consequently, wealth gets built. Getting rich is not going to be a problem for the person. I know so many of them, who mind their own affairs, and have gotten rich along the way. And I admire them more than others. But, our typical money manager will not do it because of greed. This manager knows that by promising superior returns to investors, there will be two advantages: One, asset management fees, irrespective of returns. Two, performance fees. This manager will get richer faster than he or she would have if other people's money was not sought. So the greed factor makes them tell others that they will make investors rich by earning superior returns; and thus seek money. Well, I give two hoots. 

The cheats

Then there are money managers, who are not capable of achieving consistent, superior returns over a long period. And they are the majority. Their pitch is the same: I will make you rich. However, they don't know how to play the game, and despite that, they get asset management fees, and some (non?) performance fees too. If investors don't call them cheats, what else do they want to name them? Investors should ask these men and women to get the heck out of their life. They are no better than mis-selling salespeople.

The ideal strategy

Now that we have dealt with both the types, what should investors do to stay in the equity game? They have two options:

The first is, if they know the game, like it, and have time to spend on it, they are better off playing the game themselves. Why give your money to others when you can invest yourself? Consistent, superior returns are more of a behavioral thing than of intellectual. Average intelligence, knowledge of accounting, time value of money, and basic statistics are all you need to do well if you have the right behavior.

The second option is for those, who cannot understand investments, or have no time and interest for it. These investors can easily invest their cash on a periodic basis in a diversified index fund. If they carry out such automatic investment operation for a long period of time, they will be assured of market returns, and also will be reasonably rich along the way. I mean rich enough to take care of their future financial requirements. Instead of worrying about purchasing power of money, they can continue to do what they are good at and enjoy life. Index investing will take care of the purchasing power, inflation, time value of money, and so forth.

Cavet emptor
In conclusion, if a money manager uses other people's money to invest, the manager is either greedy, or a cheat. Take your pick.

Also, it is always the caveat emptor that buyers need to be blamed first for choosing to buy without understanding consequences. There is always enough time to build wealth and resources to take care of our needs, but never enough to feed our greed. 

buffeted by buffett

Warren Buffett is a great buy. If he had not done what he has done, we would not have had the Warren Buffett we know. Sharp, witty, and an amazing storyteller. He is a cult. I have mentioned earlier as well that he has shaped my thought process in a major way, both in investing and in life in general. Needless to say again, I admire him a lot. 

Berkshire Hathaway has never paid out any dividends, nor has it bought back its stock so far. The reason: Buffett feels that he can allocate capital better than his fellow shareholders. And why not? History is with him. The strategy has worked superbly over many decades. Yet, now the time is different; he is working with truck loads of cash that he needs to allocate in a manner that returns higher than alternative opportunities. Admittedly by him, repetition of historical returns is getting way tougher. 

There is at least one investment that has not gone well with him in the past decade. Never mind that I don't like the product personally. Coke is all fizz and fuss; sugar and soda. And that's the reason I had a fourth question for him. In 2007, Berkshire had 200 m shares of Coke, representing 8.6% ownership, the market value of which was $12.274 b. In 2012, it had a 2:1 split, and Berkshire owned 400 m shares, representing 8.9% ownership, and worth $14.500 b. In 2016, the 9.3% ownership in Coke had a market value of $16.584 b. The increase in ownership was due to Coke's share buybacks, in which Berkshire never participated, Buffett being an all time fan of both Coke as a product and a business. 

Berkshire's investment in the stock had a high market value of $12.864 b and a low of $9.092 b in 2007. The values were $16.264 b and $13.316 b in 2012; and so far in 2017, the high value has been $18.972 b and the low has been $16.176 b. Berkshire neither bought, nor sold any Coke shares during the last decade. Therefore, the original 200 m shares have become 400 m post stock split. When we consider high values throughout, the return for the first five years from 2007 to 2012 was 4.80%. And for the next five years from 2012 to to date in 2017 has been less than 3.13%. The return over the last decade has been less than 4%. 

Now some math. If Buffett had sold the shares in 2007 at a high value of $12.864 b, and invested in Berkshire's (his own) alternative opportunities, the investment would have been much more than the current value of $18 b. If the opportunity cost of 10% is considered, the loss to Berkshire and its shareholders has been $15 b. When you madly fall in love with the stock, you have some serious consequences. 

What about the opportunity cost of his fellow shareholders? Surely, some or more of them would have dealt with the cash better than Buffett. Check out the S&P-500 just for comparison, and you will know. What next? Is he going to be in a denial mode all through? Hasn't Coke lost its mojo? It's a surprise, surprise that all-sugar-and-soda had its magic prevailing over the century; the stupidity of humans knows no bounds; remember, some of the smartest guys we know have extraordinary fondness for the can; and that's a debate for another day.

In May 2017, I did suggest to return cash back to the shareholders to mend themselves. Of course, Buffett is human, and is entitled to his share of mistakes. But would he listen now? Surely, you're joking, Mr...

hdfc bank, where can it go

HDFC bank's market value of equity was Rs.367 b in 2007; it was also available for Rs.198 b in the same year. Now, the whole bank is worth Rs.4750 b. That's a massive change in fortunes. And there is a reason for that. Earnings per share has increased from Rs.7.15 to Rs.59.52 during the period, even after accounting for dilution. Check this out: the number of common shares outstanding increased from 1.59 b to 2.56 b, adjusted for a 10:2 split in 2012. 

Market share has been steadily increasing. More importantly, the bank has been managed exceptionally well by Aditya Puri and his team. Book value per share increased more at the rate of 24.42% annually during the last decade. Mere increase in book value is meaningless if do not consider how good the book equity is. And that is measured by the quality of its advances, which were at Rs.5854 b, and  increased at 28.7% annually. Gross NPA was 1.05% in 2017, and net NPA was 0.33%. Including restructured loans, net NPA was 0.43%; that is phenomenal. Compare that to ICICI and Axis in the private sector, have a look at the entire public sector banks, and we will get the picture. Its equity capital is healthy too, with Tier 1 capital at 12.79% in 2017. 

The bank has excelled in other parameters as well. Its return on assets was 2.09% in 2017. Net interest margin was 4.30%. Average CASA ratio was 48%, which makes its cost of funds lower. Cost to income was 44.50%. Return on equity was 20.53%.

The story has been so good for the bank that its investors have really reaped rewards. The low base of a newly incorporated bank, and the advantages of a superior management have been clear. But where does it go from here? Is there anything left for the new investors to achieve superior returns?

The problem is that a good quality company always commands premium valuations. HDFC bank's price-to-book was 5.71 (high in 2007) and 3.08 (low). During 2008, 2009, and 2010, it was available at less than 3 (low). Even during 2014, 2015, and 2016, it was available at less than 3 (low). The high PB was never more than 5 during 2009-2016. I am measuring the ratio based upon latest annual historical numbers, rather than projected book numbers. Now the bank is selling at 5.18 times 2017 book equity. From March to September 2017, the book value has increased making it lower than 5 probably.

With the mess that has been around in the public sector banks regarding low quality book, their need for fresh equity is imminent. And, with the digital push from the government, it is reasonable to expect that the market share of public sector banks will gradually diminish, and private banks will gain. HDFC bank stands to gain from two counts: one, because of the sectoral changes shaping the economy, and two, top class reputation. 

HDFC bank will grow; but we do not know by how much. It will also command superior valuations compared to its peers; but again, we do not know how much. The bank's stock was trading at a high value of Rs.1454 during the year ended March 2017. In eight months time, it is quoting at Rs.1854 per share, a gain of more than 27%. 

Should we wait for the declines, or should we buy in bulk for the next decade? Or, should be accumulate on a periodic basis, averaging out the cost per share? My guess in terms of the strategy and results, is as good as anyone else's.

amazon q3 2017

Amazon announced its third quarter financial results. And here's the thing:

For the nine-month period, revenues of $117 b comprise, $12 b of AWS, and $105 b of the regular Amazon. That is 40% growth for AWS, and 27% for Amazon. The operations include Whole Foods business post its acquisition.

Operating income was $1,979 m, of which AWS was $2,977 m. What's going on? Yeah, Amazon suffered an operating loss of $988 m. Ok, North America showed profits of $1,144 m, but with a margin of 1.66%. International operations have continued to lose; for nine months, it was $2.1 b. 

While revenues have been growing, its core operations have not been great, yet. I have to say yet, because, the markets are forever willing to bet on Amazon. Its stocks are trading over $1000 per share, making Mr.Bezos, the world's richest along the way. Amazon never ceases to amaze me. 

Let's move to cash, for that is what is counted. At the beginning of the period, it had cash of $19 b excluding marketable securities, and over nine months, it ended with a little over $12 b. That means, it consumed a net cash of over $6 b. This story is not that meaningful. 

So we go first to the operating cash. How much cash did the operations generate during the period? It was positive cash earnings of $6 b. So far so good; collectively, Amazon and AWS generated some cash. This cash belongs to both lenders and common shareholders. Before attributing it to the capital providers though, Amazon needs cash to feed its growth projects, and there are many of those. It consumed $7 b for its capital expenditure. Boom...that is all of operating cash, and some more; now it is short by $1 b. During the period, it also acquired Whole Foods for more than $13 b. Effectively, Amazon's operating business, which from now onwards will include Whole Foods, used over $20 b cash compared to $6 b cash accruals. That is a net negative cash of over $14 b. If we are willing to bet that Amazon will not venture into more acquisitions in future, we can exclude that $13 b as a one off item. The chances are that it will not be the case. Even when we spread that number over say, 3 years, it becomes $4.5 b of annual acquisitions cost. So average annual capital spending would be over $13 b. Put another way, Amazon will have to generate operating cash of over $13 b just to breakeven. To be fair, Amazon did generate $15 b and $17 b for the twelve-month period ended September 2016 and 2017 respectively. Also its earnings are understated due to expensing of its technology and content costs. If we adjust that, its earnings will shoot up substantially. I will come to that later.

But where do its capital providers stand then? Amazon has debt of $25 b on its books. It raised $16 b to fund Whole Foods acquisition. It had to, remember it did not have enough cash. It is another matter that for a growing company like it is, which does not have stable, sustainable cash flows to service debt, increasing debt is not a good idea. But, that damn thing called equity dilution is pervasive...

It is fair to say that Amazon does not have any free cash flows for its shareholders, yet. Yet is the word, for the markets expect the business to do extremely well in future.

There is a goodwill allocation of $13 b, which I am going to ignore despite the accounting anomaly, we have no other choice. And for discussions on how it is an anomaly, I will keep for another day.

Its operating business looks like this: Assets $92 b; liabilities $66 b; that's net assets of $26 b. Then there is cash equivalents of $23 b. Total capital is: $25 b debt; and $24 b equity. Annualized return on capital was 10%, and return on equity was a little over 6%. These are improved figures compared to the prior periods; so the Amazon story is building up, isn't it? 

Now, for equity investors the equation is like this: What kind of returns is the business going to give on its book capital of $25 b? For an expected return of 10%, Amazon operations should generate $2.5 annually, and growing based on retained equity. For 15%, it is $3.75 b.

These numbers are prior to the adjustments due to technology and content costs though. When this is done, both capital employed and operating earnings will go up, and therefore, return on capital will change. For Amazon, it should increase.

For new shareholders, it is a different question. With a total market capitalization of $525 b, what are the expected returns? Even when we apply 52.5 times earnings multiple, the business has to generate $10 b in earnings.

As noted earlier, there is one key adjustment to be made in all this analysis. Amazon spends tons of money on its research and development activities for which the benefits are going to accrue in future periods, but the entire costs are expensed in accordance with the accounting rules. It spent $38 b during the previous three financial years. For 2016, the technology and content costs were $16 b. These costs are to be capitalized ideally and a portion should be amortized each year based upon the number of years the benefits are supposed to accrue. Take your pick; but is Amazon really worth $525 b?

I come back to my original hypothesis: Is Amazon a hype, or is there something we have missed, and the markets have not?

quality stocks, what to expect

Recently a friend of mine forwarded a report presented by an analyst, who is quite popular in the investing community. It was about buying quality stocks and getting excess returns. The key points of the report were: Investors tend to use higher discount rates to bring the estimated cash flows to the present value. All high quality stocks trade at large premiums. And because of that, their expected buy price never comes across. As a result, they miss high returns over the long period. And therefore investors should instead use a lower discount rate. Then they will have a higher present value for their stock; and lo and behold, they can buy the stock, and make make higher returns for a long time. It appeared cool to many, and why not?

I was surprised after I read the report; it was an interesting thought indeed, except there was a catch. The whole idea of discount rate and expected returns was pushed apart, and how. I have written about expected returns in the past. Expected returns are never precise. The aim should be to increase the purchasing power over time, rather than asking for more than what is warranted. CAPM is great, but has its limitations. Although it starts with the right footing, it falters when we come to measuring risk in cash flows, and unnecessarily looks for precision. And so does the concept of margin of safety, which is both overrated and getting more due than it deserves. Perhaps I will have to do a more detailed post on both CAPM and margin of safety.

Value of any business is the present value of its cash flows over its lifetime. We need two things: Cash flows for the entire period; and a discount rate to bring them to present. Simple, profound, but a complicated affair. How do we know what cash our favorite business will throw until its liquidation? The size of cash flows and their timing have a significant effect on present value. Therefore, our estimation task is futile to that extent. This is one reason why it is prudent to stick to businesses which are more likely to be stable over the period of our investment. Stable businesses tend to throw out stable cash flows; so our work is that much easier; but not as easy, because it still involves estimation.

If our cash flows estimation is getting difficult because the business is complex, or is subject to disruptions, or because of some shit, we cannot compensate it with either higher margin of safety (which all value investors do) or higher discount rate (which all other investors do). It doesn't really matter whether you try to eat shit with a spoon or hand, you are still eating shit. Most value investors don't get it.

Once we have our estimated cash flows, we need a discount rate. CAPM provides some framework on that, which is still the best tool available with us. It requires one adjustment though. Let's start with a risk free rate, and say that our investment returns will have to be higher than that. How much higher, is a great question. It is not volatility as measured by beta times equity risk premium. It should rather be based upon qualitative analysis and our own expectations. Short term volatility is investor's best friend for it helps in picking stocks at the right price, and then proves that often markets are inefficient. And yeah, beta is shit; period.

When our expected returns are 15%, we discount cash flows at that rate, and our expected returns will be 15%. In reality though it could be 10% or 25% because of at least two things: One, our estimated cash flows are wrong always. Two, markets can be more pessimistic or optimistic than our own estimates. The key point, however, is that when we expect to make 15%, we discount the cash flows at 15%, not 10%. This is the flaw in the aforesaid report of the analyst.

The guy is making a point that we should discount the cash flows at a lower rate so that we can make returns higher than that over the period. How profound...

What I would do for a quality stock is what I do for not a high quality stock too. A business that is not high quality may have cash flows that are visible for a short period of time. Why shouldn't we use those cash flows and discount them based upon our expected returns over that (short) period? Why should we use lower discount rate for a high quality business when we want much higher returns?

The analyst missed another key point. It is to be able to play the waiting game. What you do is analyze the business, and have a rate of return expected from the stock; and then wait for the markets to offer you a chance to get that. If that means waiting for more time, so be it. There is another way to play this as well. If you think that markets are not willing to give in, and your patience is running out, you can lower your expected returns, discount the cash flows at that rate, and see if the stock can be bought at that price. Again, these decisions are made based upon quality of business and interest rate environment. When risk free rates are 5%, your expected returns can be lower than when they are 10%. Long term interest rates change the course of our expectations.

A better game to play is to check the implied rate of return in the market price, and see if that is suitable for us. If not, we have to play the waiting game, and rely on the market's histrionics. I do know that there are times when markets are too kind to us; and a better investor waits for such times of cuddling.

For quality stocks, we can use lower discount rates for minimum acceptable rate of return, and then say that anything higher is icing. What we cannot do is, use lower discount rate, and then say we want returns higher than that.

The truth is that markets set higher premiums for stocks as long as they remain high quality. That means what we should be doing is look for those stocks that are high quality in terms of business and management, and then discount the cash flows, which are usually large and growing, with a rate, which is higher than risk free rates. And, how much higher is again a great question...

investment in property

I have noted how property prices are a delusion as prices were firming up in 2012. Later in 2013 prices appeared too high compared to cash flows associated with them. And in 2016 I noted that rentals were not aligned with prices in India. Recently, someone asked me why I do not invest in property. This is what I said: 

There are two caveats before I begin though. First is that I am biased towards equities. Naturally, I will banish everything else. But then so is everyone; aren't all biased too? Second, I don't have an edge in the game. My knowledge on property market is limited; and I neither fancy nor am I interested any further.

There are at least five reasons why I don't deal with the property market. 

1) I buy assets based upon an intrinsic valuation that I carry out. For a real property, say an apartment in a building, the cash flows are rentals net of maintenance costs. As noted in my earlier posts, rental yields have been too low in India. With a 2% yield for instance, the investor will have to say a prayer if the expected returns, including capital gains, are to be reasonable. I do not indulge in hoped-based-only instruments. Of course, we need hope all the time in life; we always hope that everything goes well. But while investing, I feel better when the probability of earning expected returns, based upon analysis, is higher, and then coupled with some hope that prices will come along with value at some point. There is always some meaningful work behind hope. 

Dividend yields on quality stocks in India aren't too high either; less than 2%. Yet, I prefer stocks. The reason is that mispricing in equity markets helps us pick stocks at prices we like. I don't find such privilege in property markets. Inefficient equity markets are investor's friend. 

2) Investing in real properties is highly concentrated with no regard for diversification. Usually for me it is not a problem when I have to buy stocks because of the comfort level I get based upon my analysis helped by the price I get to pay. Absent such comfort, property market becomes even more dangerous. For instance, with say, Rs.20 m, I would rather pick five stocks than throw the cash for one single apartment. The hope-based investment becomes prominent, and you will have to desperately seek a greater fool for your expected returns. 

3) The liquidity in equity markets is another reason why I prefer them. It takes time to first find a seller, and then to find a buyer in order to complete a property transaction. Heck, it is too much of a hassle. 

4) Tax regulations are too kind to equities in India, where as of now, there are no taxes on long term capital gains. And dividends are, generally, tax free. The difference could be enormous compared to the property especially when the transaction value is usually large. 

5) Then there is the fifth reason why I don't deal with the property market. I do not know it yet though.

Beware that you can defy equity markets; property markets have the capacity to defy you. The game is on.

d-mart, goldman, and idiots

Goldman Sachs, recently, recommended Avenue Supermarts as a buy and set its target at Rs.1,586; it currently trades at Rs.1,086 per share. That's an upside of 46%; want it? 

The stock was priced at Rs.299 per share when it was offered for public listing in March 2017; but the euphoria was evident as it closed the day at Rs.641.60. Well, the exuberance has not evaporated, yet. 

At the time of the offering, the company was priced at Rs.187 b. At the listing date, it was priced at Rs.400 b. As of now, the market price of the company is Rs.678 b. And now, Goldman is pricing it at Rs.990 b ($15 b). 

When EBIT grows 13 times, and EPS grows 30% annually over 10 years, magic happens. Euphoria combines with exuberance. 

Let's do the math. EPS for the year ended March 2017 was Rs.7.67. I don't buy the shit about weighted average number of shares, and Rs.8.48 EPS as reported in the financial statements; those are as per the accounting standards. 

When EPS grows 30% over the decade, it will be Rs.105.75 in 2027. So, if we expect 12% return on investment, the stock has to trade 32 times its earnings in 2027 as compared to 141 times now. But who wants 12%? Let's ask for 15%; for that, the stock should trade at 42 times. For 20% expected return, the multiple rises to more than 63 times. For 18%, it is 54 times. We are nearly there; in a decade, the stock will have to trade at 54 to 63 times its then earnings in order for the investor to earn a decent return. 

It's a simple math; but where's the catch? Retail is a tough business. We have seen in the past how Walmart killed other retailers, and how the current times are so testing for its own business. Online retailing, and ecommerce are set to takeover in future. Can d-mart survive it? Nobody can tell now, but with some rationality, one can say that over 50 times earnings is too much to ask from a retail business. 

D-mart reinvested Rs.20 b in the last three years. If it has to keep pace with its growth estimates, reinvestment has to continue. When stories about the Indian demography, consumption, low base, high growth and so forth are told, the growth story has to be matched with the reinvestment story. During the last six years, the company has not had positive free cash flows to the firm; in fact, it had a cumulative negative FCFF of Rs.12 b during the period. Is that a surprise? If you want to open stores, you got to put the cash back. And if you fall short of internal cash earnings, you got to look outside for cash; and if that happens for too long, it is not going to be good. 

So how do we value d-mart based on its cash flows? As of March 2017, d-mart had Rs.19 b cash and Rs.15 b debt. Let's assume its after-tax EBIT (March 2017) is free cash flows; wishful thinking, but hold on. Some more wishful thinking: Let's say FCFF grows 30% annually over the next decade; and let's assume that it would reach to Rs.75 b in 2027. We will then have to value it based on an expected rate of return. 

If we use these high cash flows over the decade, and then apply a perpetual growth rate set equal to the stable growth rate, and discount them at 15% rate of return, we get a value of Rs.314 b for the entire equity. At 18%, it is Rs.217 b; and at 20%, Rs.177 b. 

Instead of using the perpetual growth route, if we apply a multiple to the 2027 free cash flows, we get a value of Rs.400 b for the equity when expected rate of return is 15%. At 18%, it is Rs.318 b; and at 20%, Rs.275 b.

Now compare the values to the Goldman's value of Rs.990 b. Also remember that we have had a fair dose of wishful thinking. We have plucked cash flows from nowhere. We have assumed high growth rates in cash flows for a long time. These two assumptions are quite powerful, and quite exuberant. And I have not even considered dilution through options, for d-mart has some options outstanding.

Will they all hold? I mean, come on...

But then again...if the stock can trade at 141 times earnings now, it can also trade at that multiple ten years later. So there is a strong case for the stock to trade close to Rs.15,000 per share in 2027. How about that? All the stupid men and women, hurry up, the stock is a screaming buy now...

value investors, india

I don't like value investors, and I have made it clear. I don't like money managers too, and I have made it much clear. There are self-proclaimed value investor communities in India, and do I have to say more about how much I loathe them?

There are groups of course, and each has sort of a leader, whom the members look up to and say, awesome every time the leader spits out something whether spoken or written. They tell stories, write blogs, and thus attract naive men and women. And then they find ways to make money for themselves by asking money from the naive to manage or through conducting teaching sessions, or something else. 

They talk about teaching investing to the public, and their own portfolio is created through mutual funds. Oh yeah, some of them are so sloppy about their work that they discount earnings. Can't tell the difference between EBIT and EBITDA; don't understand that depreciation is a genuine expense. 

Many of them are SEBI registered investment advisors. Man...if you are good at investing, can't you stick to your philosophy and invest your own cash, and be an honorable person? Do you have to use someone else's money to pay your bills? Some of those, who don't invite cash for investment, charge fees for their gibberish. Man...can't you just be honest about the fact that you ain't no good for the investment game, and therefore need cash to pay your bills?

Man...you discount earnings? whatever happened to depreciation, capital spending, and working capital requirements? You guys talk about CAPM and its evils, yet, use higher discount rates for riskier cash flows. You harp about margin of safety, and yet, implicitly use a method to protect your follies in estimating cash flows, which is another way to say that cash flows are riskier. 

You make a living out of Graham, Buffett, and Munger, and some lesser mortals. Some shame guys, before you tell stories to idiots, who are incapable of knowing that they can earn market returns very easily without any efforts. 

I admire those, who use their own money to invest, or even borrow to invest, which means two things: one, they are confident about their skills, and two, they have skin in the game; they eat their own cooking. And there is the third, they are confident of paying their bills through their investing skills, not through fees generated from either managing money or teaching lessons. 

Twitter has made the game much easier to play. It's a pity that the public is stupid enough to be gamed. 

earnings growth, expected return

Nifty tanked 157 points yesterday, which is a 1.56% fall from the previous day. This happened after some time, and especially when people did not expect it. The market euphoria seems to be there still, although the index trades close to 26 times earnings now. 

What people do not understand is that there is a business behind every stock, and therefore, the index is nothing but a giant conglomerate comprising of 50 or more businesses. We cannot view the prices in isolation, for if we did, we will have esoteric numbers, which otherwise will be difficult to explain. 

A better way is to think about what we can expect from the current prices. If we expect Nifty to give us an annual return of say, 12% in the next 5 years, we will have to think about two numbers: earnings at year 5 and a multiple to apply at the time. Let's use a multiple of 20, which itself is not pessimistic, and 5 years from now the expected Nifty will be about 17500. So far so good. The catch, however, is that to achieve that the earnings will have to grow at 18% annually over the period. Is that doable? Yes, of course; but I always like to think in probabilistic terms. So how likely is that to happen? Well, a lot of things will have to fall in place before that can happen. It's been quite long since Nifty clocked that kind of earnings growth; very long. 

That is for Nifty. How about individual stocks? If the index can give a return of 12%, we would like returns from stocks to be at least say, 15%. Let's stick to that. The Nifty-50 stocks have been trading at different multiples, mostly unsustainable over longer period. If we can normalize the multiples, and then check how much earnings will have to grow to achieve our expected return of 15%, it should make sense. 

So here's the story for the 50 stocks within Nifty.

The blue line shows the current PE of each stock; and the red one shows our expected, a little more reasonable multiple. I have been careful not to assign a too low multiple. So I believe that the expected growth rate is on the lower side, rather than higher. Let's take for instance, Eicher Motors, which is trading at a PE of 50, and I have assigned an expected PE of 30. We can see how much the blue line is off the red line. 

When I analyze stocks, I pick all numbers from the reports published by the company. However, here for this exercise, I have relied on the external sources to pick current earnings and multiples. To the extent that it might have errors, the numbers could be unreliable. Yet, I believe that this should give us a fair idea about whether the growth in earnings is probable. Although book multiples are better suited for the financial stocks, we get the idea for them too.

Now we move to the expected growth in earnings:

As we can see, most of the companies will have to grow their earnings by more than 20% annually over the next 5 years in order for us to give a return of 15%, based upon our expected multiples. ACC, for instance, will have to grow at 47% annually; and Cipla, 37%. I have ignored Tata Steel, which has negative earnings, and the multiple did not make sense. Still, Tata Steel stock price will have to move from 654 to 1316 to give us our expected return. How likely is that? Or how likely is that these Nifty companies will be able to grow their earnings as pointed out by the chart? Will Zee Entertainment be able to grow its earnings by 24% annually?

PE multiples are also based upon the fundamentals of the business, which is driven by the cash flows, growth, and risk in those cash flows. The higher the operating and financial leverage, the higher the risk, and the lower the multiple. The more consistent the cash flows, the higher the multiple. But there is a limit to the multiple assigned because it is mostly dependent upon the growth in earnings and cash flows. The earlier we get it, the easier it becomes for us to check the market. 

If we are too quick to assign future prices to the stocks at present times, naturally we will have to tone down our expected return, which is what has happened now. Blame it on the guys on the street.

infosys board immature

On 18 August, the Infosys board released a statement squarely blaming Mr. Murthy for the CEO's resignation, and it went a little further than that.

The board goes again:

It said Mr. Murthy has repeatedly made inappropriate demands:

It concluded by stating that the board has no intention of asking Mr. Murthy to play a formal role in the governance of the organization. What a remark.

While I read the statement I found it a bit funny, and my take on the whole drama was that it was funny. Post appointment of Mr. Nilekani as the new chairman, there was a big shuffle in the board, which was great, although there was a need for a little more. Two former CFOs of the company were apt when they said what they said. 

Then came some more funny moments with the board. On 25 August, the board made a statement again:

I read it again for the sake of clarity; I said, no, it can't be that comical; heck, it was. First, blame the guy, then say it was not the intention to blame. People around are not idiots. The height of immaturity was apparent in the 18 August statement. And  now, I don't know what to say. The better thing would have been either to retract the previous statement, or if that was not possible, at least keep mum. The board has been reshuffled already; all that is needed is to repair the damage and look to the future. 

Investors don't want the shit like, it wasn't our intention to...They are more mature. Yeah, there have been more articles on how the founders have to get off. Basically, they just don't get the point Mr. Murthy is making. You do have some rotten apples in the box, which you cannot help.

The board is in the right hands now; and we do hope that Infosys gets out of the mess.

infosys, analysts and investors

Here's the low-down on the analysts take on the Infosys stock as of today.

You could lose money on the stock according to IDBI Capital, while you could gain as much as 22% as per Jefferies. 

Is there an investor who is betting on the stock for one year? The person should be a trader, rather than investor, for the investors bet on the probability that the business behind the stock is going to do well over a long period. 

My take is that if the earnings per share grow at 5% over the next 10 years, the stock is going to give a return of about 8% including dividends, and a little more than 5% excluding dividends. 

By doing the buyback, Infosys has already done the job of EPS increase for the next year. Post buyback, Infosys will have 2173 million shares outstanding down from 2285 million. Operating earnings remaining constant, the earnings per share will increase by a little over 5%. Any upside in earnings, will increase the per share growth rate.

It is fair to say that for Infosys the operating earnings are expected to grow, not fall, even if it is at a lower rate. If it performs buybacks on a regular basis over the period, yeah, with much lower amounts, 5% increase in per share earnings should not be too difficult, again probabilistically speaking. Any higher growth rate should only increase the rate of return over the period. How much can Infosys grow? That is the question everyone has, and everyone is guessing. During these uncertain times, the guesswork is murkier. 

So, do you want it? Or, is there any other business that you can look at giving you more than what Infosys can give? Tough times, isn't it?

infosys stock, why buy it if you don't believe in it

I have long back compared Infosys with TCS, and I said I was not going to buy into these stocks as there was too much to predict. 

Then I noted in Feb 2017 on how founding shareholders have the right to ask questions of the board on corporate governance matters. I also wondered how the remuneration committee, audit committee, and board could behave in the manner they did. In April 2017, I wondered how an investor in Infosys could make 35% return; and then I wondered whether it was probable. Then in June 2017, I noted how the managers were taking desperate measures what with their take on the risk factors filed in their 20 F.

In my view, the Infosys board and its managers have become a laughing stock. They first list the founding shareholders (they call them activist shareholders) as a risk factor impeding the company's growth. Later they tell the media that the founding shareholders are their well-wishers. And now they blame the founder for the mess that they themselves have created both for the business and its shareholders. 

Any shareholder has the right to ask questions about the way the company is run. When it is from a significant shareholder, there is much weight. And when it is from Mr. Murthy, the board is better off dealing with it as a top priority. 

None of Mr. Murthy's questions have been answered; and the board has the audacity to blame him for all the shit that has been going on. The CEO resigns, and takes on a role of executive vice-chairman. The board blames Mr. Murthy. Even while the shit is falling down, there is some comic sense. 

There are questions of the former CFO severance compensation; the former general counsel and chief compliance officer severance compensation; the Panaya deal; the (former) CEO compensation; and finally, because of all this, of the corporate governance itself. As a former CFO, Mr. Pai puts it, the board has failed in its duties. 

Well, there are many who have been talking good of both the board and managers and putting Mr. Murthy down in the process. They are entitled to their opinions. Yet, transparency is the key for any business organization if it has a long enduring story to tell. Otherwise, the story has to end either slowly or rather abruptly. This is the choice every business manager has to make.

Also, what do you expect from someone who does not even have skin in the game as they say? All shares owned are free; 44,886 free shares: not a penny, well almost, put in from pocket to buy shares of the business you believe in. The CEO also has (unvested) restricted stock units. So the number of free shares are much higher. But hey, they are free.

For those who defend by saying that those shares are a part of the compensation, here's the question: If cash was given instead of stocks, would the CEO have spent that cash and bought stocks? It is ridiculous to see the chairman of the board having virtually no stake in the business. Of course, Infosys is not an exception. Yet, I would have no faith in people who do not put where their mouth is. The logic is simple: if the business fails, they do not lose anything. In fact, they might even gain by hefty severance pay.

Infosys stock fell nearly 10% today after the CEO's resignation. The equity is available for Rs.2120 b now. The analysts are all over talking about how it is either a cheap or an uncertain stock depending upon whose opinions we hear. A 10% fall in a stock is not a big deal for an investor having faith in the business and its execution. So it should really not matter if there is conviction that the growth is visible and business model is sustainable. 

If due to the CEO's exit the execution is going to be an issue, then the investor will have to weigh in, and sell the stock when the price is more appropriate. There will be some opportunities in the near future for such action although a big blown price rise may not be there.

The shareholder-board-CEO saga is not new. It has been going on for sometime. So, the investor who is skeptical of the business execution should not have bought the stock at all, or having bought it, should have sold it when the stock price hit some higher levels, which the stock did in the recent past. Equity buying is not meant for short term gigs. Have the intention to participate in the long term performance, or don't just buy stocks. 

If the idea is to trade and speculate, short term is game. In fact, Infosys is just ripe for such action. I don't believe that the returns are going to be great by owning the Infosys stock. May be just about the market index; or slightly higher if lucky. I do like to trade in it though. Speculating with some insignificant cash is both fun and thrilling. The returns are also going to be insignificant. And on top of it, I get some comical scenes like the one going on right now. 

Of course, I noted in Feb 2017 that stock buybacks are good only when the company has excess cash and the stock price is lower than its intrinsic value. Is the stock price still cheap? 

amazon, is that a hype

At $986.92 per share, Amazon's equity is worth $474 b. Beginning 2013, it was $121 b; 2014, $182b; 2015, $137 b; and 2016, it was worth $270 b. Beginning 2017, it was $379 b. Is there any stopping to this story? The world has been bullish on the Amazon story, and for too long; threatening every business, they are asking, is Amazon coming for you? Is this going to be true, or all hype? 

I have been valuing Amazon for long, and every time, I must admit, I have found the stock to be overpriced. Noting about it in March 2013, I asked if anyone knew it in advance.

In February 2014, I wondered how long is long term for Amazon, which was worth $160 b at the time.

I acknowledged in May 2015 that it is indeed a disrupting business; but then, I noted that the business is yet to make money. At $200 b market value, the storyline was this, and continues to be so:

In September 2015, it was time to talk about price and value. At $235 b market value, Amazon was on its course, as per Analysts of course, to move past $300 b. 

I compared Amazon with Berkshire Hathaway in July 2016, and noted the differences in price and value. Both were priced by the market at $350-360 b at the time. 

And I did ask the question, again, where's the cash?

And by March 2017, we were talking about how Jeff Bezos could become the first person to be worth $100 b as Amazon goes past $600 b.

I also noted that the market, if not the business itself, has the potential to take Bezos past $100 b.

Now we are in August 2017, and Amazon just released its June quarter results. As of June 2017, it had cash of $21 b, and operating assets of $9 b. Such low operating assets was due to its reliance on supplier payables of $35 b. You have to wonder about its business model, after all. The non-cash working capital is negative $21 b, amazing indeed. There is a long term debt of $7.6 b. It has only $42 b of long term assets excluding goodwill.

With $9 b in operating assets, Amazing is ruling the world, what with the market capitalization of $475 b. While shareholders have put in only $23.2 b, net of cash it is hardly anything. Put in another way, if it pays off its debt, the balance sheet will look like this:

Operating assets $9 b; Cash $ 14 b; and Equity $23 b.

Can someone with $9 b available for investment replicate its business model and disrupt Amazon? It looks so simple, yet so formidable. Book $9 b, market $475 b; is there some mismatch here? Alright, I am manipulating a bit; you can add another $15 b, which is approximately the accumulated depreciation to date. Still, $24 b of investment and you get $475 b in market value is something to ponder over.

The only profitable segment for Amazon is its AWS, which includes cloud computing. AWS is about 10% of consolidated revenues, but contributes entire operating profits.

Operating profits: North America made profits of $1032 m and International segment suffered losses of $1206 m, resulting in Amazon's operating losses of $174 m for the 6 months ended June 2017. It is only after AWS you see the consolidated operating profits turning positive to $1632 m.

AWS made operating profits of $1806 m for the 6-month period. The question is, why AWS should be Amazon? Both are, sort of, unrelated businesses. If AWS is incorporated separately, the market will have explicit numbers, and therefore may be more rational in pricing equity. AWS is an IT solutions business and therefore will have to be valued as such.

Amazon is an online retailer competing with both other online e-commerce and brick and mortars like Walmart. Then we can see clearly that Amazon is yet to make operating profits. Although it is generating operating cash flows, we do not know how much of that is attributable to AWS.

Excluding AWS, Amazon had revenues of $66 b for the past 6 months. How much can these grow in the next decade, or even after that? Of course, the world is its market. Yet, how much? What would be its long term operating margins? There are lots of questions of Amazon as a business, and much more of the market's expectations and pricing.

While there are more bullish on Amazon, we also find some who are on the other side of the story. And with this kind of market pricing, they are not very happy. Is it going to fall, or is Bezos going to be the richest guy on the planet? That's a trillion-dollar question.