Essay: Amazon inc – analysis

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  • Subject area(s): Business essays
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  • Published on: May 8, 2017
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Amazon.com is an online-retailer and cloud-computing company headquartered in Seattle, Washington. The company is primarily based on E-commerce and is one of the largest companies in the world. Originally, Amazon was simply an online bookstore but quickly diversified into selling electronics, software, apparel, video games, toys, food, jewelry, MP3 downloads, DVDs and many other things. While Amazon was originally founded in the United States, the company currently operates in over 15 countries worldwide. Through its different business ventures, Amazon has been able to become a world leader in sales with its main competitors being Wal-Mart, Barnes & Noble, eBay, Alibaba, and Apple. Through their diversification, the company consistently has high sales levels.
Jeff Bezos who is still the current President, CEO and chairman of the company founded Amazon.com in 1994. While originally basing its business on online book sales, Amazon quickly diversified to many other aspects of business, expanding its scope of business to products utilized all over the world. After quickly diversifying business operations, Amazon has been able to capitalize on popular trends such as online video streaming, the use of drones to deliver packages, adding groceries to its list of products sold, implementing Amazon Prime and getting into the “cloud” business of producing online storage for individuals. In addition to adding these various business facts, Amazon has developed into one of the world leaders in the retail business. Amazon’s unique business of operating specifically on the Internet has allowed the company to reach new consumers and infiltrate various consumer markets around the world.
Some of the major services that Amazon offers include online video streaming, Amazon Prime, computing services, retail sales, consumer electronics and digital content. These services allow Amazon to compete with companies such as Netflix, Wal-Mart, eBay, Barnes & Noble, Apple, Alibaba, and various retail stores and companies whom are in the smart phone industry. By diversifying in such a way, Amazon is creating a business model that can essentially compete with any company. Amazon is a “one-stop shop” where consumers have the ability to purchase anything they could need and get the products they ordered in a timely manner. Overall, Amazon’s business model is to be so diversified that they make it hard on consumers to shop anywhere else as all of their needs can be met online with Amazon.
Investopedia.com defines the WACC as, “A calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. All capital sources – common stock, preferred stock, bonds and any other long-term debt – are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and an increase in risk.” In the case of Amazon, we calculated the WACC as being 7.27%. To calculate this number, we used a beta of .88, a risk-free rate of 2.5% and a market premium rate of 6%. Knowing this number is important for a company because it is the way a company gauges how much capital they will have to fund future projects. Essentially, the lower that a company’s WACC is, the cheaper it will be for the company to fund new projects. This is incredibly important to investors because when one invests in a company, they need to know what kind of future the company is going to have and how much capital they have to increase their business ventures. In regards to the WACC that we calculated for Amazon, it is not an ideal WACC for a company to have but it is also not a detriment to furthering their business options.
In addition to the WACC, we also estimated the cost of the long-term debt of Amazon. Within this, we found that the tax rate is 31.8%, the cost of long-term debt is 4.74% with an after-tax cost of long-term debt being 2.39% and that Amazon is a Baa1 bond rating. Knowing what a company’s bond rating is, is important because it indicates the credit quality of a company. Private independent rating services such as Standard & Poor’s, Moody’s and Fitch provide these evaluations of a bond issuer’s financial strength, or its the ability to pay a bond’s principal and interest in a timely fashion (Investopedia.com). In regards to investing, it is important to know all of these numbers and percentages because it allows an investor the necessary information to know as to whether or not they would want to invest in said company.
In respects to the operating margin, this is the measurement of a company’s revenue that is left over after paying for variable costs of production that include wages, raw materials, etc. For a company to have a healthy operating margin, the company must be able to pay for its fixed costs such as interest on debt. This essentially allows analysts to have an idea on how much a company makes on each dollar of sales before interest and taxes are factored in. In determining the quality of a company, one must compare said company’s change in operating margin over time and in turn, compare this to the company’s yearly and/or quarterly figures compared to those of its competitors.
In the case of Amazon, their operating margin is 0.2%. What this means is that over the past year, Amazon is making 0.2 cents on the dollar. This number is important because the operating margin measures the efficiency of a company. The higher that a company’s operating margin is, the more profitable that the company is. This is important because it highlights how a company is doing financially. In addition to this, the operating margin is a good indicator to investors on how a company is doing and if they will have the means to expand their business in the coming years.
The difference between Amazon and the rest of the industry in regards to their business strategy is that Amazon is primarily based online and has a significant diversity business plan. Unlike its competitors, Amazon is extremely diversified. Unlike Amazon, Apple and Barnes & Noble are not very diverse. Apple bases their business operations on the electronic market, cloud operating systems, software and MP3 downloads. Barnes and Noble is not significantly diversified either, primarily focusing on the retail book market and is a retailer of content, digital media and educational products. Because these two companies are not as diversified as Amazon, they have a harder time competing with the larger company as Amazon can meet an individuals every need with one stop.
In regards to Wal-Mart and eBay’s relationship with Amazon, the three companies are more similar. Wal-Mart and eBay are diversified companies, similar to Amazon. However, Amazon has an advantage over Wal-Mart. Rather than needing to drive to a store, customers can simply get all of their products online through Amazon. This is also advantageous for consumers that do not live within driving distance of a Wal-Mart. According to Bloomberg, “In 2015, Amazon surpassed Wal-Mart as the most valuable retailer in the United States by market capitalization.” The eBay business plan in regards to Amazon’s is a little more complicated. While eBay is a retail online store, they run their business much different than Amazon. While Amazon has a lot of products individuals need, eBay does as well. However, when working with eBay, consumers are working with other individuals to purchase items. Essentially, one is dealing with a person whom they have never met and do not know if the product they are purchasing is exactly what the seller described. With Amazon, a customer never has to wonder whether or not the product they are receiving is what they ordered. Amazon guarantees the products when they are purchased from the company.
Overall, while all of these companies have similar products that they sell, Amazon has diversification on its side as well as the backing of a major company. In addition to this, most of the products the other companies sell are also sold by Amazon, without the hassle of having to leave one’s home or face the disappointment of not receiving the product they believe they are receiving. What this essentially means for Amazon is that they will be able to outcompete their competition because of the vast majority of products they have. This is important because with the ability to outcompete these other companies, Amazon will have very high sales margins. These sales margins will allow them to have significant market share that will lead to their stocks being more valuable and entice individuals to invest in the company.
Investopedia.com describes ROIC as, “A calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments. The return on invested capital measure gives a sense of how well a company is using its money to generate returns. Comparing a company’s return on capital (ROIC) with its cost of capital (WACC) reveals whether invested capital was used effectively.” The ROIC for Amazon is -.6% for 2014. This ROIC is not ideal for a company. The general rule of thumb is that a company had developed a successful business plan if they are running an ROIC of 15%-20% year after year. While Amazon is not generating this high of an ROIC, their company is still generally viewed as a successful one because of the significant volume of sales in which the company operates on. This volume of sales allows Amazon’s stock to remain high. With the stock remaining high and continuing to increase in value, people are enticed to invest in the retail giant. These continuing investments allow Amazon to promote growth and allows the company to continue being the retail giant it has been since the early 2000s.
Throughout the duration of this project, we have been tasked with valuing Amazon.com. In order to valuate a company, one must understand what the valuation means. What valuing a business means is determining the economic value of a company. One values a company to determine the fair price of a business for many different reasons, including finding out the sale value, assisting in establishing partner ownership and to aid in divorce proceedings. Generally when valuing a company, one would review financial statements, discount cash flow models and comparing the company one wishes to value with companies of similar business practices. With this in mind, we valuated Amazon. The result from our model includes an estimated price of 633.31 at the end of our most recent fiscal year and a WACC of 7.27%. We calculated this buy using a Beta of .88. Amazon has a Baa1 bond rating and currently has more than 468 million shares outstanding as of the end of their 2014 fiscal year. This is giving them a market value of common stock of $286,417,047,600.
Unlike most companies, Amazon does not pay dividends to their stockholders. CEO Jeff Bezos argues that their razor-thin margins are what continue to keep Amazon competitive. If Amazon were to give dividends, they would be forced to change their strategic plan, which could potentially create problems for their business model. As for stock splits, Amazon has only had three splits. The first was a 2 for 1 split in 1998, followed by a 3 for 1 split in 1999 and finally a 3rd stock split also in 1999. A very interesting thing that Amazon practices is paying workers to quit. Once a year, associates are offered $2,000 to leave, which is headlined “Please Don’t Take This Offer.” This offer increases by $1,000 each year, with a limit of $5,000. By having this in place, Bezos believes that he will continue to retain associates and employees who are fully invested in the company. He is quoted saying, “In the long run, an employee staying somewhere they don’t want to be isn’t healthy for the employee of the company.”
In the last month, Amazon stock price has risen from $573 to $672. Over the last year, Amazon has continued to grow at a rapid rate. While some believe that Amazon will not continue to increase, I do not believe that this is the case. Due to their debt, they still believe their stock is undervalued and will continue to increase in the future. They also have many aspects to their business, which will continue to grow. When discussing on a YTD basis, Amazon’s stock price has increased over 118%, where the S&P500 has only increased at a rate of 2.12%. While many do not see this stock continuing this trend, Amazon is continuing to put their earnings back into the company, showing that they believe the company has not yet reached its peak. This huge raise in stock price is due to many reasons, but can be concluded that it is due to their diversification. By continuing to get into more markets, they are continuing to grow their company. As Amazon Web Services (AWS) continues to grow, so will their brand when they take on new projects. Also, their development on the Delivery Drone has also had a very positive effect on their stock price.
Overall, we believe Amazon is in a great position to continue to outgrow the market. What they have done in the last year shows just how much their company is excelling. Their projected forecasts also are a positive, as their one-year target estimate on finance.yahoo.com is at $721.42. As well as this, many investors continue to upgrade AMZN, making it a ‘Buy’ or ‘Strong Buy.’ While this is only the opinion of investors, Amazon’s track record speaks for itself. They vision the company to be “The Earth’s most customer centric company” and have succeeded up to this point. Also, many of their projects for expansion are still in the development phase. When services such as the Delivery Drone are made available, Amazon will continue to grow at a much higher rate than the market. This drone service will take delivery to a new level and all of their competitors will have to continue to catch up to Amazon’s revolutionary growth. AmazonFresh is also a grocery service that Amazon has begun to invest in. In cities such as Seattle and New York City, they have done very well. Due to this success, they are beginning to create more of these grocery service’s in other high populated cities. Lastly, the population in the world is continuing to rise. As 60% of Amazon’s revenues are coming from their Web Services, I believe their revenues will only continue to increase. As more citizens convert to online shopping, Amazon will continue to see increases in sales and revenue. While there are critics who believe Amazon has hit its peak, I believe that they are diversified enough where they will continue to excel in many markets.

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