Open season on high flyers, particularly when quarterly numbers disappoint. Amazon jitterbugged 10% intraday (last Friday). Alphabet’s swoon reached 7%. Previous weeks, IBM was taken out and shot. AT&T broke below $30, its yield approaching 7%, which is ridiculous even on a lackluster quarter. No safety in value stocks, but General Motors popped on its good numbers. Microsoft now is number two in the S&P 500 Index, maybe ready to displace numero uno, Apple. Both stocks carry reasonable valuations, no more than 20 times earnings, with Apple nearer 18, just above the market’s number.
Who can match Secretariat, whose oversized heart measured bigger than a pineapple? When Secretariat was led out of his stall for his early morning workout, he’d rise up on hind legs in pure exuberance. His stable boy would coax him down. “Come on down Big Red, come on down.”
Read the Street jockeys’ music sheets on Amazon and Alphabet. You’d think they were handling Secretariat, straining to hold their mounts in check until the top of the stretch run. What’s curious, none of the 40-odd analysts following these two pieces of paper called in their buy recommendations to hold or even “sell.” What’s crazy, price forecast adjustments were just a couple of points on stocks that tick in the thousands. In Street lingo, a “growthie only becomes a sale after it ticks down into single digits, an obvious basket case.
At some point in the market’s swoon, you’re supposed to step in and buy while the locals are panicking. My valuation point is 15 times earnings for the S&P 500 Index. We’re 4% away. This assessment is historically based. Fifteen is the market’s trend line just so long as inflation isn’t out of control and bonds afford a real rate of return of 1.5%. All this is pretty much what we’re seeing today.
I own Alphabet because I dare think it’s analyzable and not outrageously valued. Amazon remains a mysterious beast that I can’t get my hands around. Jeff Bezos plays the analyst fraternity, issuing worthless guidance at his quarterly meetings. His financial reports rest opaque. Only when new divisions are thriving, like the cloud sector, does he break out earnings. But no feel on market share, pricing and competitive forces.
Ironically, the next most highly valued property on the Big Board penny-pinched its unskilled and part-time work force. I remember Amazon employees in Germany striking for a working wage. Finally, the new wage floor is $15 an hour. McDonald’s isn’t more than a year away with comparables for its part-timers who make up 80% of the workforce. Same goes for big retailers who carry huge part-timers.
Lemme dig into Amazon’s September quarterly report, a most devilishly presented document. The initial metric they hit you with is in their leading sentence, namely operating cash flow, updated on a 12-month running basis. This is a big number, up 37% to $26.6 billion. I’m assuming $35 billion for calendar year 2019, but mine is a horseback number derived from recent years’ rate of change.
If I’m close to right, Amazon sells at 23 times 2019’s operating cash flow, but not earnings. Still, it’s a critical metric because operating cash flow is the wherewithal to invest in old and new business initiatives. Amazon ain’t shy about funding new ventures with serious money. It’s how the cloud sector got its legs.
On free cash flow, another valuation metric, Amazon sells at 40 times my projection, again on horseback. Some $20 billion, a 2.5% yield on a stock with an $800 billion market capitalization. Not enough to excite anyone. When free cash flow yields approach 5%, I get down to work, studying the property in question.
Unlike Alphabet, Amazon is not run for its employees. Stock compensation is minimal, what looks like a $6 billion annualized spend, under 1% of Amazon’s market valuation. They carry minimal long-term debt, approximating net liquid assets of cash and marketable securities.
The Amazon enigma centers on where revenues seem headed. Its AWS sector (the cloud) now earns as much as their basic e-commerce business, which is split between the U.S. and international. But offshore revenues, half as much as North America, earn zilch. When does a revenue base over $60 billion start to earn serious money? ¿Quién sabe? Bezos gives us no clue. The cloud business earns as much as e-commerce. How do you model both sectors? You can’t creep into Bezos’s brain, alas!
Again, on horseback, I’d compare Amazon’s e-commerce revenues, say, with Walmart as to potential operating earnings power as a percentage of revenues. Amazon should do better. It doesn’t employ over 2 million “associates” like Walmart does. But extrapolating earnings based on revenues is tricky and imprecise. Nobody knows. Based on what I can work with, operating cash flow, Amazon is a bull market stock, presently a luxury.
Alphabet is a horse of a different color, the dominant player in mobile search. Conceptually, I’d compare Alphabet with the old Time, Inc. magazine empire in the fifties. Time and Life dominated print media then. Advertising and subscription revenues waxed buoyant, and the stock sold OTC around 20 times earnings, even then. Henry Luce’s hubris was comparable with today’s geeks.
Whadda we get for our money in Alphabet? Well, the market was disappointed in its quarterly numbers, both revenues and operating income. Despite the slough off, revenues rose 21%, but operating income growth was in single digits. Sequentially, the quarter’s paid clicks rose 10% while cost per click declined by 7%, a good metric.
Alphabet is a financial fortress with $106 billion in liquid assets. Debt is next to nothing. The stock sells at four times book value, but nobody pays this much attention. The research and development spend here is easily 15% of revenues, a serious number even for a tech house. When I take off the European accessed fines this year and put a normalized tax rate of 20% on operating earnings, I come up with $35 billion to $40 billion in earnings next year.
We’ve got a reasonably working price-earnings ratio approximating 20 for Alphabet. But, unlike Amazon, stock grants to key employees carry a big number, 20% of net earnings on latest quarterly numbers. This 20% level is my cutoff point for investing in a tech house because it raises the potent question of who’s the primary constituency—shareholders or themselves?
If I saw recession around the corner, I’d sell Alphabet. But I’m in the 3% to 4% GDPcamp. Advertising revenues shouldn’t be so critical a variable near term. When I look at what you can buy for near 20 times earnings—Coca-Cola, Procter & Gamble, even Boeing, Microsoft and Apple, which I like—Alphabet is fair value. I’d hope to see them break out all their profit centers, but like Amazon, they’ll keep us in the dark until they have a lot more to crow about.
As for Amazon, the most extremist forecast I’ve seen is over $44 a share for earnings in 2020. This puts valuation at 36 times on a most conjectural sum with scanty factual backup.
Gimme a break!
Sosnoff and / or his managed accounts own: Amazon, Alphabet, AT&T, Microsoft, Apple and Boeing.