In February, I dropped some Berkshire Hathaway and bought some Amazon. When the market crashed in March due to the initial COVID-19 panic, I moved most of my money into cash. Then as I gained confidence, I bought more. Amazon is where most of my cash is invested.
If you read my 2014 article Lazy Investing, you might say I am contradicting myself. Actually, that article was an example of confirmation bias. (I have that tendency, and perhaps this article should poke more holes in my conclusion.) It took me five years to realize that the article was about convincing myself about my existing conviction.
I have to thank many lunch time conversations with Janis and Evan for challenging my convictions. I also have to thank Warren Buffett for saying “You have to learn how to value businesses and know the ones that are within your circle of competence and the ones that are outside.”
In this article, I document my investing strategy promoted by my rethinking in February. I discuss my asset allocation, but the primary focus is an attempt to value Amazon, because I believe it is within my circle of competence to do so. I want to know if my big bet on Amazon makes sense.
Some investment advisors would have me put 60% of my money in bonds and the rest in stock. Others say 110 or 120 minus your age in stocks, or 50-60%, in my case. I think formulas like this are ridiculous, and not based on actual circumstances.
I own real estate. How much is it worth? Real estate is a leveraged investment. What should my leverage be at my age? How much should I keep in real estate vs cash vs bonds vs stock? I also own a significant chunk of two private companies. These are highly illiquid assets. Should I divest? If so, when?
Some people would say I should be paying off your mortgage before I retire. Others would say that my privately held stock is stock, and I need to adjust my publicly held stock accordingly. None of this is incorporated in the age-based calculations of stocks vs bonds.
My portfolio is a victim of circumstance. I lived in a house, and I didn’t sell it when I moved out. Janis is a real estate agent, and she thinks real estate is a good investment. One day she told me to buy another house so I did. Unlike stocks, you can’t just drop a house for another one so I keep the houses for many reasons: inertia, the solid real estate market, and personal circumstances. Owning real estate diversifies my asset allocation.
My 401K only allows me to invest in mutual funds. During the COVID panic, I moved it all into a long term bond fund (VBLTX), because I figured it was slightly better than the money market. The fact that I can’t put it in Amazon is a good thing, but why not put it in the S&P?
“Consistently buy an S&P 500 low-cost index fund,” Warren Buffett told CNBC’s On The Money. “I think it’s the thing that makes the most sense practically all of the time.”
If you have a long horizon, this makes perfect sense. Perhaps if I hadn’t put all my savings into myriad startups, I’d have more savings now, and a bet on the S&P would have paid off. However, I have less savings than I need to retire, and I am confident that 1) I can work till I’m 75 and/or 2) I can take on much more risk so I might not have to.
COVID has created uncertainty like I have never seen before. The stock market is driven by fear-of-missing-out (FOMO) investors and/or speculators. I decided in March to sit out of the S&P for a while. If I lose a year’s gains, so be it. I can have a multi-decade horizon on my 401K funds, since I’m being more agressive with my other accounts.
So my asset mix is pretty random. I do not think there’s a formula that could help me with my unique situation. I also know that I need to be aggressive with a large part of my portfolio so that I can retire comfortably.
How to Get Rich
I wrote Objectively Rich in 2009. It talks about how to get the best money manager by looking at the richest people in the world. Buffett was/is near the top, so I concluded I should invest in Berkshire Hathaway, alongside him. Not unsound, but I missed something.
When I was thinking about a money manager, I was thinking about investing in a diversified portfolio. I already have asset diversification (noted above). The question is: do I need diversification in an asset class? Or, is it better to make big bets on individual companies, like Amazon? The question isn’t: which money manager should I hire, but with whom can I invest. That opens up more possibilities.
Even in 2009, I recognized that the richest people in the world built single company. Buffett built Berkshire Hathaway. Gates create Microsoft. The richest list is even more heavily populated by tech and retail/consumer companies. I certainly tried my hand at getting rich like these people on my own companies, but I’m not like these people. They are clearly different from me.
Jeff Bezos is currently the richest person in the world. He graduated with a degree in computer science and electrical engineering from Princeton in 1986. Excellent credentials to do any job, and he did have a few jobs before starting Amazon. He has been focused on Amazon since 1993. I appreciate his single-minded focus, and it obviously has worked out well for Amazon.
Bezos is ruthless. I have heard that from people who have worked for him. To make Amazon big, you have to be ruthless. I’m not ruthless. I don’t generally like ruthless people. Steve Jobs was ruthless. Bill Gates was, too.
Amazon, Apple, Microsoft, etc. are as big as they are, because of these ruthless leaders. That’s harsh, but competing in business is tough, especially retail. Sam Walton was no doubt ruthless, too, and according to this article so was Frank Winfield Woolworth before him.
Lots of people love working for these behemoths, despite their ruthless leaders, or maybe because of them. I’m not one of them of these people, but I can certainly invest in these companies, because I think their leaders do what they have to for their stakeholders, which do include their customers and workers. Despite what many think, these companies would not have grown so quickly if they treated their customers or workers badly.
Amazon used technology to sell retail, better. That’s one of my reasons Amazon is the best bet among the tech giants. Retail is a huge industry: worldwide retail sales are $24 trillion per year. People need to eat and to clothe themselves. World income is rising, and along with it, consumerism. (I’m not saying this is a good thing, but it is a hard fact.)
Retail is a fickle business. I would not want to run a retail business. You have to move with the trends. Amazon moves with the trends. We are in the middle of the COVID-19 Pandemic, and Amazon stopped all deliveries of non-essential goods to its warehouses. That’s because at Amazon, it is always Day 1.
That’s another reason why I don’t mind so much about how ruthless Bezos is: he has done great things for our society by focusing on Day 1:
- Created a logistics business that employs many hundreds of thousands.
- Despite the criticism of Mechanical Turk, I believe it gives people work anywhere in the world, out of their own homes, and on their own schedule.
- Amazon’s Kindle Direct Publishing platform virtually created the self-publishing market.
- Prime made shopping online competitive with Walmart and Costco.
- Echo was the first home digital assistant, which now enables thousands of small businesses to reach homes. For example, my nephew’s company, MapHabit, which is enhancing the quality of life of Alzheimer’s patients and their families through cognitive tools delivered via Alexa.
- Marketplace allows over a million sellers to fulfill product deliveries without ever touching the product itself. Marketplace revenue just crossed 50% of Amazon’s total revenue, that is, third party selling is a $140B business and growing.
Walmart has been trying to compete with Amazon for a decade or more. I have bought stuff from Walmart both on and offline. Walmart’s revenues ($514B) are still bigger than Amazon ($280B). The difference is that Walmart’s growth has been under 10% for the last decade, and Amazon’s has been over 20%.
There are other big companies, e.g. Apple, which are growing almost as fast, but Amazon is growing faster. It surpassed Apple’s revenues this year, and it is on track to surpassing Walmart in a couple of years.
Amazon’s growth is diversified. It isn’t just selling retail. AWS is growing by over 30%, and it, too, is becoming more diversified. The range of options on AWS is so mind boggling that a whole industry as formed to help you manage AWS.
Retail is a huge industry, which means there’s lots of room for growth. Amazon has changed the industry forever, to both the industry’s and Amazon’s benefit. I can see at least another decade of double digit growth.
Eat Your Own Dog Food
Technology is key to Amazon’s success. Companies like Google and Facebook, also became successful through technology. However, technology at Amazon grew up around a problem: selling things. Then, it grew into a thing on its own: Amazon Web Services. Neither Facebook nor Google eats their own dog food like Amazon does. It’s funny, when I searched for this Wikipedia page I typed “Eat your own dog food” and the first completion on Google was “Eat your own dog food Amazon”.
Dogfooding is important. If AWS is down, services at amazon.com might be broken. I have used a number of cloud providers, and none of the big ones work as well as AWS. (I do like and use Linode.com, but they are a niche provider.)
Microsoft were the original dogfooders. This made Windows more reliable. I wonder if they are dogfooding their cloud products. From my own experience with Azure (Microsoft’s AWS competitor), I would say not likely, even though Microsoft is Number Two in cloud computing. Azure is clunky to use, and I only know a few people who use it.
Cloud Computing Revenues
Investors pay a lot of attention to The Cloud. I’m less interested, because it is a small part of Amazon’s revenue. AWS revenue was $35B in 2019 – if we take it as face value, more about this later. AWS grew from $25B in 2018, and is on track to increase by that much again in 2020. Amazon’s total revenue in 2018 was $233B, and rose to $281B in 2019. That’s 20% growth in a much larger market ($24T). Yet, I know that investors pay attention so should I.
One question I had is whether AWS recognizes revenue from, say, Prime Video. A recent 10-K states “Costs to operate our AWS segment are primarily classified as ‘Technology and content’ as we leverage a shared infrastructure that supports both our internal technology requirements and external sales to AWS customers.” I take from this statement that they treat “internal technology” as a cost. I don’t think it would be legal for them to recognize revenue from internal “sales”, and enough people are watching that I feel safe in that assumption.
Investors are very excited about Microsoft, which has a higher market capitalization than Amazon, despite having only $126B in revenue in 2019 and $110B in 2018. Growth at Microsoft has been less than 15%. It’s strange to me that their market cap is so high. The big excitement in the news is Azure growth, but there’s a problem: Microsoft is hiding Azure revenue numbers.
Azure revenues are important, because I would like to know if AWS is far and away the biggest cloud service, or if competitors are eating into AWS’s revenue. Microsoft’s Intelligent Cloud segment includes Azure, GitHub, Windows Server, SQL Server, Visual Studio, and Enterprise Services (Consulting and Support). Intelligent Cloud revenues were $39B in 2019. However, no one seems what Azure’s standalone revenues are.
I tried to do my own analysis, and gave up. Microsoft keeps on recategorizing “commercial cloud” to mean something else, and it seems to be getting bigger. (Go to the 2017 and 2019 annual reports and search on “Revenue from external customers” to see what I mean.)
However, I am pretty sure that Azure revenues are a small percentage of the $39B stated in 2019 for the same reason that Amazon didn’t post seperate numbers for AWS during its first nine years. Small numbers are not interesting to investors. If Azure growth is 72%, it’s not on $10B, because the delta between 2018 and 2019 Server Products and Cloud Services is $6B.
My conclusion is that Microsoft is not eating AWS’s lunch, at least not yet.
AWS has had its share of outages, some huge, while others lost customer data. They could be hit again. I’m very critical of cloud infrastructure, specifically the Big Red Button. Yet, the cloud is here to stay, and despite all these problems, AWS is still considered a leader.
Counterfeit merchandise is a huge problem for Amazon. They luanched the Counterfit Crimes Unit recently, which hopefully will help with this. Nike stopped selling directly on Amazon, and other big brands sometimes shun Amazon.
Failed products are not uncommon: Fire Phone, Local, and Register were the biggest. It seems that Amazon kills products pretty quickly, and doesn’t seem to infuriate customers like Google does.
The recent antitrust hearings in Congress did not go well for Amazon. It is difficult to see how Amazon would be seen as a monopoly, but regulators could force Amazon to make changes. Amazon tends to beat regulators to the, e.g. by setting a minimum wage of $15 that is double the Federal minimum wage. They were very aggressive in their handling of COVID. I don’t discount the regulatory risk, but I also don’t think it’s the biggest risk.
Jeff Bezos, I believe, is the achilles heal of Amazon. If he were to die unexpectedly, the stock would take a big hit, and maybe the company would never recover. Can Andy Jassy or Jeff Wilke fill Bezos’s shoes?
There is no way to mitigate this risk. You either live with it or not. My guess is that the stock could drop as much as 50% if Bezos were to die suddenly. That’s a big risk, but it’s the problem with betting on one company, even one as large as Amazon.
Investors seem to be more and more decoupled from the fundamentals of companies. Losing a CEO is important, but to run a large company, you need lots of company people. That doesn’t mean anything if the “market” reacts to news, which it does.
My plan would be to ride it out. I believe in Amazon as a business for all the reasons above and more.
My Circle of Competence
Unlike Warren Buffett, I am a technologist. I understand why Amazon made the decisions they made in their technology. I have friends who have worked at Amazon. I have started many different companies, and I get what it takes to be a success. Dogfooding and Day 1 are key concepts that I try to employ.
I interact with Amazon on a daily basis. I read on my Kindle every day. I often watch Amazon Video. I buy things for my home and businesses on Amazon. I use Amazon Web Services. I listen to Music, which I start by talking to Alexa via my Echo. I listen to audio books on Audible. Buffett knows Dairy Queen and Coca-Cola, I know Amazon. I’ve been a customer since 1998 when I moved back to the US, and I spend thousands per year at Amazon businesses.
But it’s not just me: Amazon trucks pass by my quiet street multiple times a day. Amazon is an integral part of my society. And, more importantly, we share the same progressive values while still believing in capitalism.
What About Diversification?
In 2008, Warren Buffett made a ten year bet that the S&P 500 would beat a hedge fund and the hedge fund manager conceded two years early. Buffett says that non-professional investors should invest in low-cost index funds. This is solid wisdom, and John C. Boggle made a fortune creating that industry.
But right now, five companies make up more than 20% of the market capitalization of the S&P 500. This is a problem for diversification. The five are: Amazon, Apple, Facebook, Google, Microsoft. So even if you invest in VOO or SPY, you are into tech, big time.
Thinking about it differently, if you are 100% invested in the VOO, you are 5% invested in Microsoft, 5% invested in Apple, etc. Those are big investment decisions to make. If you are looking for diversification, 5% is a big number. Moreover, Berkshire (number 6) holds about 5% of Apple, which makes up 40% of its holdings right now and growing.
I use Apple products, but I am not a fan of Apple as an investment. They do sell retail, but they are focused on a narrow range of products. It is hard for them to be agile. That’s why I am not betting on Apple.
Diversification is thought to be safe, but it leads to owning a lot of Day 2 companies. There are 500 companies in the S&P 500, and I would not buy a single share of most of them. Why would I think “in aggregate” that the S&P 500 is a good bet? I don’t, any more.
In the end, I’m making a bet. That’s why this article isn’t called “Investing in Amazon”. This is a big bet that involves significant risks. It’s not for everyone.
I have tried to clarify my thinking about the bet in this article. I have to thank Evan for his clear-sighted review of the first version of this article. I revisted my thinking and made it much more personal.
I wonder what I’ll be saying about this article in 10 years.