It is always worth remembering that when stonks appear to grow to the sky, it is actually sky-diving which is likely next on the agenda. For instance, during 1998-2000 the NASDAQ 100 appeared to attain lift-off from its tenuous mooring in the net income of its constituent companies, rising by 300% to a peak of 4,700 in less than 24 months.
But then came the March 27, 2000 blow-off top and 20 trading days later the index was off by a gut-wrenching 30%, only to stutter long enough at 3,000 for buy-the-dippers to come in for one last killing, which slaughter proved to be their own. By October 2002, the index had lost 83% of its peak value, and at 800 it actually posted lower than it had stood way back in December 1996 when Greenspan warned about irrational exuberance—and no one paid attention including the Maestro himself.
NASDAQ 100 Blow-Off Top And Crash, 1998-2002
Needless to say, that was a warm-up. Here’s the left-hand side of the same chart, which is destined be become the 300% NASDAQ 100 blow-off top of 2021. This time it took a tad longer to reach low-earth orbit, but the index did touch 7,000 as recently as March 23, 2020 when the US economy hit the skids under the Covid-Lockdown shock and the Eccles Building went full retard on the printing presses.
Alas, 16 months later main street is still short 7 million jobs and GDP has barely reached its Q4 2019 level, but stonks are up 100% and the homegamers are piling into this sucker’s rally like never before. Of course, that’s exactly what happened in early 2000, at which point they soon morphed into the lemmings which plunged into the cold waters depicted on the right-hand side of the above chart.
NASDAQ 100 Index, 2016-2021
To be sure, the talking heads are again pounding the table, insisting that this time is truly different and that powerhouse profit gushers like Apple, Google and Facebook are nothing like the eyeball-chasing dotcom stocks of 2000. Supposedly, the FANGMAN are some kind of financial Atlas that cannot fail as they hold up the froth-ridden stock market on their own immensely profitable shoulders.
But that’s actually slim comfort. When the market cap of the Wilshire 5000 rose from $7 trillion to nearly $14 trillion in the run-up to March 2000, it wasn’t powered upward by the likes of famous flame-outs such as Webvan, Kozmo and Pets.com. As we indicated in Part 2, that era’s equivalent was the Four Horseman of Intel, Microsoft, Dell and Cisco—-all large and highly profitable companies that have turned out to be among the most innovative enterprises created in modern times.
The problem was that they were massively over-valued, and it was those extreme valuations that accounted for the $6 trillion of bottled air which came whooshing out of Wall Street when the last mullet finally hit the bid on March 27, 2000.
For example, Cisco was then valued at $500 billion on LTM net income of $2.6 billion. While the latter was by no means shabby relative to $15 billion of sales, the implied 192X PE multiple turned out to be the stretch that never saw daylight.
Cisco’s sales and profits never faltered and the latter today stands at $10.2 billion, but that’s just the problem. The embedded compound growth rate computes to an earth-bound 6.7% per annum over the 21-year period. That pedestrian growth rate couldn’t have remotely sustained its nose-bleed PE multiple, and has resulted in its current market cap of just $235 billion. That is to say, after two decades and counting there is still no prospect of recovering the year 2000 value in either this lifetime or the next.
The outcome for Microsoft was somewhat better, but the story still stands. It’s $23 billion of LTM sales and $9.2 billion of net income posted in March 2000 went on to much bigger and better things, as befits the technology powerhouse which it was then and remains today. But its March 2020 LTM figures of $139 billion of sales and $46 billion of net income were nevertheless earth-bound, reflecting CAGRs of 9.4% and 8.4% per annum, respectively, over the 20 year period.
Needless to say, when you start with a 60X PE multiple in March 2000, it’s hard to stay abreast of even these moderate growth rates. In fact, Microsoft’s market cap stood at $1.14 billion in March 2020, representing a mere 3.7% per annum gain from the March 2000 value.
The Robinhooders’ would surely say no dice to that—as they expect that kind of return daily, not over two decades. As it turned out, it was only the Fed’s $4 trillion flood of free money after March 2000 that lifted Microsoft’s PE back into today whacko zone at 36X, which has added a cool $1 trillion to its market cap since then.
Then there was Intel, undoubtedly one of greatest high tech enterprises ever created, yet an absolute cautionary tale with respect to the FANGMAN’s soaring PE multiples. At the 2000 peak, its market cap hit $300 billion against sales of $33 billion and net income of $10.5 billion. But despite years of continued technology innovation and dominance it could not live up to its 30X PE multiple.
During the last 21 years its sales have more than doubled to $78 billion and net income stood at nearly $19 billion as of the June 2021 LTM period. But, alas, those outcomes computed to growth rates of just 4.1% and 2.8%, respectively.
So after a steady de-rating of its PE multiple to just 11.7X, the homegamers who piled into Intel in the spring of 2000 are still waiting to pass “go”, stranded with a market cap still 25% below its September 2000 level.
And that gets us to the supposedly gravity defying rocket ship called Amazon (AMZN). Like Microsoft in March 2000, it is a world-beating innovator and it also happens that its current $1.71 trillion market cap represents exactly 60X its $29.4 billion of LTM net income. Yet unlike Jeff Bezo’s recent two minute escape from the inexorable pull of gravity, Amazon is truly earth-bound and from it’s current Covid-Lockdown fattened sales level of $433 billion it has no possible way to earn its PE multiple by escaping the earth-bound rule of GDP growth.
After all, Amazon is 28 years-old, not a start-up; and it hasn’t invented anything explosively new in terms of end demand like the iPhone or personal computer. Instead, 89% of its sales involve sourcing, moving, storing and delivering goods—a sector of the economy that has grown by just 2.2% annually in nominal dollars for the last decade, and for which there is no macroeconomic basis for an acceleration.
Yes, AMZN is taking share by leaps and bounds from the crumbling world of bricks and mortar, but that’s inherently a one-time gain that can’t be capitalized in perpetuity at 60X. And it’s a source of “growth” that is generating its own push-back from the bricks and mortar world—-a headwind that has been only temporarily abated by the the flight to eCommerce of home-bound shoppers.
Walmart’s eCommerce sales, for example, have exploded after its purchase of Jet.com several years ago. During its FY 2021, eCommerce sales reached $65 billion or 6X the level of 2018. Likewise, Target’s eCommerce sales now exceed $20 billion and are growing rapidly, as is the case for most other big box retailers from Home Depot to Lowe’s, Kohl’s and a host of other survivors.
All of these companies are learning how to leverage their massive existing asset base for duty on the eCommerce side. In the case of Walmart, for example, this includes using its 4,700 stores as customer pick-up sites and even a free four hour delivery option called “Pickup Today”. The company is also tapping for eCommerce fulfillment duty its vast logistics system—including its 147 distribution centers, a fleet of 6,200 trucks and a global sourcing system which is second to none.
To be sure, the 2020 lockdown shock did accelerate Amazon’s North American retail sales growth to 40% versus prior year, as consumers abandoned retail stores owing to orders of the state or fears of the Covid. But that’s just the point. Amazon’s robust sales growth represents a one-time capture of the shift to eCommerce, and the 2020 shock only accelerated that process toward its completion.
During the prior two years, for example, North American retail sales grew by slightly less than 20% per annum, a rate of gain which will now bend toward the single digit line as the transition is completed and debt-ridden American households have just 2-3% more to spend on retail goods each year, if that.
Likewise, for those who believe that net income and pre-tax income are antiquated concepts, the story based on operating free cash flow is no less prohibitive. After nearly three decades of operation, AMZN still generates minuscule operating free cash flow—which for the LTM period ended in June 2021 amounted to just $7 billion.
That’s right. AMZN generated $59.3 trillion of cash flow from operations, but a staggering $52.3 billion was plowed back into the business as CapEx.
Relative to its massive sales and nosebleed valuation, of course, this tiny number is almost farcical. It represents just 1.6% of sales and amounts to a free cash flow multiple of 244X!
Alas, that computes to a cash-on-cash yield of just 0.4% for anyone of a mind to buy AMZN at its current lunatic share price. And, oh, that tiny yield is purely theoretical: Amazon has never paid a single dime of dividends.
Needless to say, you can get a 1.2% yield today on a 10-year Treasury note, and Uncle Sam actually pays that in cash. So why get in harm’s way by taking on Jeff Bezos’ relentless empire building and megalomania in order to stump up an even lower non-cash yield?
And that gets to our larger point about Amazon allergy to profitability. Between 2011 and 2021 Amazon’s net sales exploded from $48 billion to $443 billion, while its operating from cash flow only rose from $2 billion to $7 billion. That is, on a humongous $395 billion sales gain it generated only $5 billion (1.3%) of additional free cash flow.
Indeed, as we show in Part 4, apart from its cloud business (AWS) Amazon is essentially not a profit making institution at all.
And that’s also where the Fed’s destruction of honest price discovery and the resulting false signaling comes in. To wit, in an honest free market, Jeff Bezos would be more than welcome to run a profitless growth machine, but it would also be valued accordingly.
Even at the highest free cash flow Amazon has ever generated—$26 billion in its FY 2020—-and at a 15X capitalization rate it would be worth about $400 billion, not $1.7 trillion; and Bezos’ personal stock would be worth $45 billion, not $195 billion!
We will readily grant that Bezos is a visionary and great capitalist innovator, builder and disrupter—who may be motivated by more than the last few billions of net worth. But we would also lay heavy odds on the probability that his business strategy might be dramatically different—and far more profit oriented—if his net worth were $150 billion lower.
Indeed, based on a rational valuation of the Amazon eCommerce colossus we think Bezos’ assault on the brick and mortar sector would be far less menacing and reckless. And that’s giving full credit to the fact that on-line shopping and nearly instant delivery of goods is an enormous consumer boon that would be making great inroads even in an honest free market.
But not nearly as rapidly, wantonly or disruptively because Amazon would be required to post a reasonable profit, and to do that its pricing would have to be far less predatory than is on offer today.
Nevertheless, until Amazon’s gargantuan stock bubble collapses, we don’t think Amazon’s strategy of growth at any price is going to change. Nor do we think AMZN is a freakish outlier; it’s actually the lens through which the entire stock market should be viewed because the whole enchilada is now in the grips of a pure mania.
Stated differently, Graham & Dodd should move over: The stock market is no longer a discounting mechanism nor even a weighing machine; it’s become a pure gambling hall.
So Bezos’ e-commerce business strategy is that of a madman—one made mad by the fantastically false price signals emanating from a Wall Street casino that has become utterly unhinged owing to 30 years of money-pumping policies at the Fed and its fellow central banks around the planet.
Indeed, the chart below leaves nothing to the imagination. Since 2012, Amazon stock price has bounded upward in nearly exact lock-step with the massive balance sheet expansion of the worlds three major central banks.
At the end of the day, the egregiously overvalued Amazon is the prime bubble stock of the current cycle. What the Fed has actually unleashed is not the Schumpeterian process of creative destruction that Amazon’s fanboys imagine.
Instead, it embodies a rogue business model and reckless sales growth machine that is just one more example of destructive financial engineering, and still another proof that monetary central planning fuels economic decay, not prosperity.
Amazon’s stock is also the ultimate case of an utterly unsustainable bubble. When the selling starts and the vast horde of momentum traders who have inflated it relentlessly in recent months make a bee line for the exits, the March 2000 dotcom crash will indeed seem like a walk in the park.