Why Jeff Bezos cares about his share price

By Felix Salmon
February 1, 2013
Justin Fox has a great little post called "How Amazon Trained Its Investors to Behave":

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Justin Fox has a great little post called “How Amazon Trained Its Investors to Behave”:

When Amazon reports below-consensus earnings, as it did Tuesday, and the share price jumps, as it did after-hours Tuesday and again Wednesday morning, the reaction isn’t quite the puzzle it seems. Slate’s Matthew Yglesias cracked that “Amazon, as best I can tell, is a charitable organization being run by elements of the investment community for the benefit of consumers.” But what’s really going on is that Jeff Bezos has trained elements of the investment community to expect that low profits (or big losses) now represent investments that will eventually pay off, not signs of trouble.

The weird thing here is the Jeff Bezos training regimen, when it comes to shareholders, is really no different to the Mark Zuckerberg training regimen, or the Steve Jobs training regimen, or even for that matter the Jimmy Dolan training regimen, of Cablevision infamy. In each case the CEO treats his shareholders exactly the same way: disdainfully, by ignoring them. And it turns out that investors, in turn, react in very different ways, depending on the CEO and the company which is doing the ignoring.

Fortune’s Philip Elmer-DeWitt has a good overview of what he calls the “bizarro valuations” of Apple and Amazon, and how it makes very little sense that Apple is selling for 10 times earnings even as Amazon is selling for more than 3,000 times earnings. On the other hand, who cares about such things, beyond stock-market speculators? The one thing that Jeff Bezos and Tim Cook have zero control over is their own stock price; they’re focused instead on the things they can control. Indeed, they probably have much more control over their companies than the vast majority of other CEOs.

Or, to put it another way, both Bezos and Cook are secure enough in their jobs (unusually, for CEOs these days) that they can afford to ignore what investors think, most of the time. Neither is acquiring companies with stock, or otherwise in need of a high stock price, and neither is going to get fired by their board. It’s fascinating to see how an almost-identical attitude towards investors, at two companies which have grown to dominate their respective markets, has resulted in such widely differing valuations.

Which leaves the question: does the stock price matter at all, to Bezos or Cook or Zuckerberg or any other CEO of that ilk? The answer is yes, for one big reason: talent acquisition and retention. If you’re running a tech company, you’re going to be handing out a lot of equity as part of your compensation packages, which mean that your employees are highly interested in seeing the share price rise — a lot. When it’s rising, they’re happy; when it’s falling, they’re not. And so even if you don’t give two hoots about your institutional shareholders, you still have to care about that share price.

That said, while “rising” is always good, in terms of the share price, “stratospheric” is less so. If you’re Jeff Bezos or Mark Zuckerberg, handing out RSUs, it’s pretty hard to make the case that you have a huge amount of upside — just because the share price is already so expensive, and your company is already so fully valued. At Apple, by contrast, the upside is still enormous, and if the team continues to deliver amazing growth figures, then the share price will eventually rise a very great deal.

Amazon and Apple and Facebook are large and pretty mature companies at this point: hires have job security as well as stock-related upside. But they all need talented engineers, and in a weird way it’s the company trading on the lowest multiples which is the most attractive in that respect. Apple’s low current share price could even be a competitive advantage, in the all-important war for talent.

Comments
11 comments so far

Careful, Felix. Nobody ever gets paid in multiples. You get paid in stock price. Amazon is only trading at 3,000 times earnings because its earnings are for all intents and purposes negligible. But if by date X in the future Amazon’s actual earnings grow 300 times faster than Apple’s do (which is not necessarily impossible, given Amazon’s low base), then a prospective employee should be indifferent between the two, ceteris paribus. All Jeff Bezos needs to do is dial back his investment or raise his prices, and that could easily happen. You just have to believe this is possible.

Posted by EpicureanDeal | Report as abusive

I think you miss a very big part of the logic in the share price by just talking about the X time earnings equation. There is a HUGE difference between the sentiment on Apple and Amazon right now because of how investors are looking at the future. The question is, in reality, who has the business model that promises the most as we head to time Y in the future, Apple or Amazon? Right now investors are saying Amazon. Why? Well, let’s put it this way, if Amazon decided to make exactly .50 more on average for each item it sells, it could. And Amazon’s “stuff” isn’t dependent on Amazon development. Apple? Not so much. 5 years from now, who’ll justify the multiple, Amazon or Apple? Right now, investors are spooked enough at what they see in Apple’s crystal ball to bid down the stock. So here, people need to be assured that Apple’s growth path continues. No one is honestly worried that Amazon’s won’t.

Posted by skyman123 | Report as abusive

Felix, you’re assuming engineers pay that much attention to multiples. In my experience as someone who hires them, they don’t. They pay surprisingly less attention to the details about stock options than they should.

As an Apple shareholder, I’d like to believe that “At Apple, by contrast, the upside is still enormous, and if the team continues to deliver amazing growth figures, then the share price will eventually rise a very great deal.” I’d like to believe that, but I can’t. I think the reason the stock has been hit so hard the last six months or so is because Apple’s sales are already so enormous that people have been wondering if they can sustain the incredible rate of growth they’ve enjoyed over the past decade. What will get tens of millions of iphone or ipad owners to upgrade in less than two years? There is no clear indication. And even if they do, their margins are also under attack, because they were forced to sell the ipad mini, which can’t bring in the same gross profit dollars as the standard ipad that it is cannibalizing.

As someone who sold AMZN at 75 because I felt the market would punish them the instant their profits stopped growing as fast as their revenues, I am envious of their share performance. However, they don’t have the same limitations on growth that Apple does – Apple is facing market saturation, while there’s a lot of retail purchases being made at places other than Amazon. Bezos keeps investing more of their profits in an attempt to get those sales, and fortunately he ignores the analysts that have no idea how to run his company.

And while Bezos and Cook are secure in their jobs, how many CEOs really get canned? CEOs are more likely to lose their jobs for harassment scandals than for poor performance.

Posted by KenG_CA | Report as abusive

“If Amazon decided to make exactly .50 more on average for each item it sells, it could”

I am highly doubtful that’s true. If it is the case, then Amazon management are fools. They should exercise that pricing power to make some money. If the excuse is that Amazon doesn’t do so in order to build customer loyalty, then why should I believe that Amazon will ever be able to do so in the future? That excuse implicitly says that raising prices will drive away customers over time.

Say what you will about Steve Jobs being disdainful of shareholders, but he was never disdainful of making money.

Amazon’s annual revenue is now over $50 billion, with year-over-revenue growth in the latest quarter of just over 20%. That is not the profile of a company that should have essentially zero profits because it is “investing for growth”. That is the profile of a company in a low-margin business with a slow payback on investment.

Amazon should also provide some insight into whether its Kindle strategy is working, but instead Amazon doesn’t even disclose how many Kindles they sell. I am very dubious about Amazon’s business model of selling Kindle Fires at essentially cost with the hope of making money on incremental (low margin) Amazon sales. Amazon ought to provide some insight as to whether or not that strategy is working.

Posted by realist50 | Report as abusive

I would not bet that Apple can grow a lot more. It is already the most valuable or next to most valuable company in the world. For it to double in value would require its becoming so large it is not conceivable. Like people, companies tend to reach a growth limit and then they tend to start to shrink for various reasons. The stock price of Exxon Mobile for example, already huge in 2008, has risen only 4.75% in the last five years. It’s probably as big as it is going to get. Companies don’t grow indefinitely.

Posted by Chris08 | Report as abusive

@Chris08 – fair point that Apple isn’t likely to get dramatically bigger than it currently is. Its current PE is only 10x trailing and 9x forward, however, so it doesn’t need to grow to justify its share price. Apple’s PE even understates just how cheap the stock is because Apple has over $100 billion in cash and equivalents that contribute minimal earnings in the current interest rate environment.

Posted by realist50 | Report as abusive

Here’s my question for the Amazon bulls: what is the path for Amazon to generate enough profits to justify its current share price?

Even stripping out all of the investments for future growth, its operating margins look to be under 5% (it achieved 4.3% in 2010, lower since then). To justify the current market cap ($120 billion), you’ve got to see a future where Amazon reaches $6 to $8 billion of net income for a PE of 15x to 20x. Gross up for corporate income taxes, and that implies pre-tax operating income of $10 to $12 billion. Assume a 5% operating margin – well above where Amazon is at today – and that implies revenue of $200 to $240 billion. Amazon’s 2012 revenue was $61 billion and grew $13 billion (27%) over the prior year. Amazon’s revenue grew $14 billion from 2010 to 2011. If Amazon keeps increasing revenue by $13 billion per year, it would take it just over 10 years to reach $200 billion in revenue. That’s just to justify the current share price at a market multiple – obviously no shareholder would be happy with a flat stock price for the next 10 years.

Posted by realist50 | Report as abusive

Felix, I think that there is this trite narrative about Apple and Amazon being similar in terms of ignoring their investors, but if you have actually LISTENED to the earnings calls, you know that that is just not true.

Whereas Amazon is completely opaque in virtually every aspect of their business, ushering numbers-free platitudes like, “our best selling Kindle ever,” Apple is deeply transparent.

They break out margins, they delineate product unit sales by category, average selling prices by product category, how that’s trending, retail sales metrics galore, performance by geography, and now they’ve re-organized the various revenue buckets so it’s easier for investors to assess how each line of business is performing (they have SIX different multi-billion dollar revenue lines).

Heck, they even pay a dividend now, which seems to make investors even less happy (they want a BIGGER dividend), whereas Amazon and Google do nothing of the sort, and not a whimper.

I blogged on this point, as I think it underscores how Apple is being penalized for attempting to be judged on the specifics of their business, whereas Amazon (and Google) have succeeded with investors by selling a fuzzier narrative:

Cry Babies: The Strange, Confusing Path of the Apple Investor
http://thenetworkgarden.blogs.com/weblog  /2013/01/cry-babies-the-strange-confusi ng-path-of-the-apple-investor.html

Check it out, if interested.

Mark

Posted by hypermark | Report as abusive

“When Amazon reports below-consensus earnings, as it did Tuesday, and the share price jumps, as it did after-hours Tuesday and again Wednesday morning, the reaction isn’t quite the puzzle it seems. Slate’s Matthew Yglesias cracked that “Amazon, as best I can tell, is a charitable organization being run by elements of the investment community for the benefit of consumers.” But what’s really going on is that Jeff Bezos has trained elements of the investment community to expect that low profits (or big losses) now represent investments that will eventually pay off, not signs of trouble.”

This is complete BS. If these people really think the market is remotely this rational, thought through or inform they need a new line of work.

“Fortune’s Philip Elmer-DeWitt has a good overview of what he calls the “bizarro valuations” of Apple and Amazon, and how it makes very little sense that Apple is selling for 10 times earnings even as Amazon is selling for more than 3,000 times earnings. ”

Umm companies are valued based on the value of their current assets and their projected earnings at some discount based on how sure those look. Why on earth would you expect them the be valued based on current earning except in extremely mature/stable industries? Is this baby’s first stock market analysis?

Posted by QCIC | Report as abusive

@QCIC – if you are so dismissive of Mr. Elmer-DeWitt’s view, please provide your view on how Amazon will grow earnings enough to justify its current 3,000 PE ratio and $120 billion market cap. His post is a short piece that admittedly doesn’t go into great detail, but everyone understands that the stock market discounts future performance. The issue with Amazon is that the 3,000 PE obviously indicates that the stock price discounts a base case future with dramatically higher earnings than Amazon has historically achieved. The underlying rationale is a mystery to a lot of people – me included – for a business that is generating low margins, has exhibited little operating leverage, and is already generating over $60 billion in revenue.

Posted by realist50 | Report as abusive

@Realist50

I’m not long AMZN and sadly never have been. I believe they will hit 200 billion in rev by 2018. The reason I think they spend so much of their operating profits on investment is that you are exactly right about their extremely high capital needs.

Amazon wants what Google and Facebook already have… the #1 position in their space across every democratic (or semi-democratic) country on Earth. Google and Facebook are lucky… their capital requirements are basically just lots of servers, even more bandwidth, and a tiny number of employees per 1,000,000 customers.

Amazon deals mostly in physical rather than digital goods and so they need to pay for Wal-mart like infrastructure (warehouses/inventory management systems) once they feel like they have that covered from Seattle to Sidney, to Stockholm, to Singapore… then they start making money.

I’m not saying I buy it… I think AMZN looks richly valued here… but that’s the thesis.

Posted by y2kurtus | Report as abusive
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