“While the value of a business is ultimately a function of the cash earnings it can produce, this should not be the focus of management or investors,” MKM Partners analyst Robert Sanderson wrote in a research note.
Sanderson has a lofty $1,275 price target on Amazon stock, which has gained 28% in 2017 as the S&P 500 index has increased 9%. Sanderson’s thesis is that executives are spending large with a long-term view, and investors have rewarded such activity with support because of what it could produce.
“We think Amazon has the largest and most tangible set of long-term growth opportunities of any company in the world,” Sanderson wrote.
Outsize spending on growth is nothing new for Amazon, which has long sought to be what famed investor Benjamin Graham described as a “heavy” stock. Executives have allocated billions to capital expenditure, building out both its cloud computing division and its vast logistics operation, as well as making expensive bets on consumer products, not all of which work out.
In the note, Sanderson offers the cautionary tale of Apple Inc. and its growth trajectory. More than a decade ago, Apple was in an advantageous position to exploit the growing mobile market, and it was able to determine how the then-nascent market would shape up with its iPhone and App Store. But, unlike Amazon, Apple did not reinvest the massive amount of cash generated from its dominance, nor exploit its unique position.
“Rather than acquiring emerging businesses or making large bets to expand its value-chain, Apple generated a huge amount of earnings, paid $110 billion in taxes, redistributed $215 billion of cash to shareholders and still has $260 billion on its balance sheet,” Sanderson wrote.
Amazon’s growth story, according to Sanderson, is centered around its retail investments as well as its cloud-computing unit, Amazon Web Services. The Seattle-based company’s strength in 12 major international markets (excluding China) will generate 40% of its commerce revenue and represent 25% more gross domestic product than the U.S. business, a difference that will “likely grow over time,” Sanderson wrote.
But Amazon will be a force in the U.S. as well, thanks to trends in retail and digital consumption, Sanderson says. E-commerce accounts for 9% of total U.S. retail sales, he wrote, which signals that it has only now become a meaningful portion of total spending.
“While initial categories like books and electronics have already seen significant impact (R.I.P. Borders and Circuit City), growth in online sales is now pressuring incumbent business models across most categories of retail,” he wrote.
To facilitate its growth Amazon has continued to provide sales, marketing, distribution and logistics functions for its direct sales as well as it third-party sellers. Doing so, Sanderson says, “is enabling a highly integrated and efficient retail platform with inherently high underlying margin compared with traditional retail models.”
Yet Amazon is still dwarfed by rival Wal-Mart Stores Inc. WMT, -0.09% Including third-party sales and recently acquired Whole Foods Market Inc., Amazon was responsible for 4.3% of U.S. consumption in 2016, while Wal-Mart gobbled up 12.4%.
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