Internet And E-Commerce Paper: How To Shoot In The Dark

Facebook founder Mark Zuckerberg. Photo by ANDREW CABALLERO-REYNOLDS/AFP via Getty Images.

When old-fashioned measurement metrics fall short, analysts and money managers focus on the multiple of revenues to market capitalization. Yahoo at its peak in 2000 sold at 100 times revenues and Amazon

AMZN
was way up there, too. In 2001, yearend, IBM

IBM
sold as low as two times sales with Microsoft

MSFT
at 14 times and Qualcomm

QCOM
at 19.5 times.

Yearend, 2019 Microsoft sold at 1.5 times the market’s multiplier. I decided that was its pivotal metric and it got me back into Microsoft. Its trailing five-year price-to-sales ratio was a lesser ratio of 3.5 times. In 2015, Google

GOOGL
and Facebook sold at 6 times and 12 times revenues, respectively, while Amazon rested at 2 times revenues, a good working ratio if you liked it, speaking conceptually, but minimal earnings.

What surprised me was Microsoft outperformed all properties excepting Amazon. My five growthies, Amazon, Facebook, Alibaba

BABA
, Microsoft and Alibaba, handily beat the market’s 50% gain. If not overweighted in tech you probably lagged the market over five years. This certainly was Warren Buffett’s experience. He did own some IBM, a non-performer that he batted out of his list. Apple

AAPL
is his surrogate for tech, but a fairly recent addition. Looking ahead, the pivotal issue for such big-capitalization properties is whether earnings momentum at mid-teens or better is in the cards.

Building income statements for these five operators is near impossible. How gauge advertising demand at Facebook, e-commerce revenues for Amazon and Alibaba? Analyst projections are horseback numbers. Jeff Bezos plays with his analyst fraternity. His numbers, always low-ball, are laughable and useless. All said, Amazon brings very little to its bottom line. Analysts look out at least three years to rationalize Amazon’s stock price. They invoke metrics like operating cash flow, price to Ebitda, free cash flow yield – anything but earnings per share.

Bezos, perennially, finds new ways to spend big blocks of cash. What saves him is Amazon’s balance sheet is underleveraged and operating cash flow is a big number. These are the only metrics I check out, quarterly.

Conveniently, the opening sentence of all Amazon’s financial reports covers operating cash flow numbers for trailing 12 months. At yearend, 2019, this was $38.5 billion, up 25%. My reasoning for singling out this metric is that it adumbrates the business health as well as providing the wherewithal for reinvestment and future growth. If you project near $50 billion for operating cash flow in 2020 you can rationalize a price of at least $2,000 for Amazon. It’s enough to keep you in the stock but not enough to make you buy more.

Amazon ticked over 2,400, although its March quarter operating cash flow was impacted by huge-spending initiatives in e-commerce to handle incremental demand during the shut-down of bricks and mortar retailers everywhere. I looked for comforting metrics elsewhere, estimating free cash flow at $25 billion. This put the free cash flow yield at 2.5%, not too comforting, but helpful to keep you from banging out the stock.

Looking at my earlier 2020 projection of earnings per share in the low thirties (which won’t be met), Amazon was selling at 70 times earnings, an unusable number for anyone involved in the stock. Nobody ever said growth stock investing was simplistic. You had to believe that e-commerce profit margins finally would approach Walmart

WMT
or Costco numbers, but it wouldn’t happen overnight, but maybe in five years.

In short (no pun), Amazon remains unanalyzable, despite a market capitalization over a trillion bucks. Microsoft’s market capitalization exceeds Amazon by some 10% and is easily mappable in terms of earnings and cash flow. Microsoft sells no more than 30 times earnings, a fair premium over the S&P 500 Index. Because it’s mappable, I’ve twice as much invested in Microsoft than Amazon.

Lemme go on to Facebook where Mark Zuckerberg and company have endured a hostile-financial press for a couple of years. But, it’s had no impact on valuation. Actually, Facebook, past 12 months was almost a double. The financial press for me is a contrary indicator. They never put emphasis in the right place.

The first Facebook metric I look at is advertising revenues. If going along at a good clip, chances are the stock is levitating, too. Advertising so far is undiminished. Facebook coasts along at a 25% revenue growth clip. This is breathtaking during the Covid-19 meltdown which so impacted traditional retailing.

A singular line in the expense column is research and development running at an annualized rate over $16 billion or 20% of revenues. R&D at 20% of revenues is nearly unheard of, even historically in the high-tech world. Nobody picks up on this outsized metric. Zuck gives out no details on spending specifics so let’s hope he connects. Eye-catching, too, is the scale-up in employment at year-over-year growth of 28%. These may be largely lower-level employees but still an enormous number.

Unlike Amazon, Facebook gives out plenty of stock to productive employees. Share-based compensation runs at a $5 billion clip, over 20% of pretax income. This is my cut-off point for investment consideration. Let’s call Facebook’s operating cash flow annualized above $25 billion. On its current 2020 market capitalization of $710 billion, call it over 25 times 2020’s operating cash-flow multiplier, a not-outlandish number that kept me in the stock after a near 50% rise from its March 2020 low. Facebook is cheaper than Amazon on my operating cash-flow projections.

The armchair investor should appreciate that operating earnings momentum drives growth stocks. It’s worth putting quarterly reports on your iPad to keep a feel for what you own. Facebook is selling on my estimate of free cash flow possibilities of $30 billion at over a 4% free cash flow. Believe this, and it’s a clincher, making the stock a strong hold. Facebook’s premium over book value is seven times, but I never heard of anyone selling a growth stock based on premium over book value. You don’t have to hold a card as a certified financial analyst to perform broad-brush strokes on growth stocks.

Sadly, these financial reports, both Amazon and Facebook, are cavalier, actually disgraceful because they offer no color or details on research priorities, what tens of thousands of new employees will be working on or the competitive forces impacting them operationally. Financial-report readers are offered a couple of dozen pages filled with comparative numbers, this year vs. last year. Hey guys, what happened to serious commentary? Am I the only one complaining?

Sosnoff and / or his managed accounts own: Amazon, Facebook, Alphabet and Microsoft.