Otavio Costa, portfolio manager at Crescat Capital, is well known for his macroeconomics analysis. He has recently stated his bearish views on Amazon stock (AMZN) - Get Amazon.com, Inc. Report. According to Mr. Costa’s post on Twitter (see below), the price of the e-commerce and cloud giant’s stock has become dissociated from the company’s fundamentals.
Today, the Amazon Maven presents Mr. Costa’s point of view. As a counter argument, we explain why his thesis could be flawed.
(Read more from the Amazon Maven: Is The Sky Falling For Amazon Stock?)
Cash flows estimates vs. valuation
The pandemic has practically turned Amazon into an essential service. As a result, Wall Street analysts seem to have gotten carried away, aggressively projecting Amazon’s revenue as they believed that the favorable trends would last even after the COVID-19 restrictions were lifted.
After disappointing Q2 results, most realized that the slowing of Amazon’s earnings and cash flows growth would be a natural consequence of the pandemic’s unwind in 2021. Mr. Costa has gone further. He believes that Amazon’s valuation is now disconnected from the company’s fundamentals. He has said:
“A remarkable divergence. Amazon’s stock price is now completely disconnected from its bottom-line fundamentals. Free-cash-flow estimates are down over 51% from its peak. Now back to its 2018 levels while prices remain near record levels. If you think this has to do with the reopening of other retailers recently, just look further out. See the chart for the free-cash-flow revisions for 2022 and 2023. A clear fundamental downtrend diverging from the stock price.”
Near term vs. long term
Financial math teaches that cash in the present is worth more than cash in the future. When valuing a company using a method like DCF, we simply calculate cash generation extending far into the future (usually ten years of full financial modeling, plus a perpetual growth piece) and discount all future cash flows to their present value.
Amazon is a high-growth company that, few will disagree, is likely to remain a dominant player in e-commerce, cloud infrastructure and consumer services for many years or decades. In the case of most growth companies, what determines the value of their equity the most is not earnings or cash flow in the next few quarters or couple of years – but in years 3 or 5 through “infinity”.
Back to Otavio Costa’s argument, a rise in Amazon stock price coupled with a decrease in Amazon’s projected free cash flows can mean two things:
- the stock is overpriced, and it may be time to sell AMZN (Mr. Costa’s thesis), especially if the cash flow decline is indicative of structural problems in the business model;
- the stock price is less dependent on cash flow in the short term and more on long term expected results.
The Amazon Maven argues that the latter interpretation is likely more accurate. Not only that, but even the short-term dip in projected cash flow in 2022 and 2023 might reflect Amazon’s willingness to invest in the business, rather than a long-lasting deterioration in fundamentals.
Amazon’s financial statements provide a hint. CapEx, for example, has been rising due to the company’s recent investments in MGM studio, the expansion of AWS’ infrastructure, and the opening of Amazon’s new brick-and-mortar stores.
Rather than fearing a near-term dip in cash flow, therefore, investors might instead be encouraged by Amazon’s willingness to fuel its long-term growth. This being the case, the market value of AMZN does not need to mirror the ups and downs of 12-to-24-month cash flow projection trends, as Mr. Costa implies.
One expert has pointed out a discrepancy: Amazon stock remains relatively high, despite sharply lower cash flow expectations in the next year or two. Is AMZN price really overstated?
Is the price right?
Looking at a company’s business fundamentals is only half the work needed to find a good stock. How much one pays to own the shares is a key factor in the success of any investment. This is why valuation analysis is so important.
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Amazon Maven)