If you had invested $1000 in Amazon on October 1, 2008, it would now be worth $37,290.90. This amounts to a cumulative return of 3,629.1% or an average yearly return of about 30%. Since Amazon has never offered a dividend, these spectacular returns would have been achieved without the benefits of compounding that come from reinvesting dividends over time.
Over the same period, an investment of $1,000 in the SPY ETF, which tracks the performance of the S&P 500 index, would have yielded $4,548.20, which amounts to cumulative and average annual returns of 345,8% and 11.47% respectively, including the reinvestment of dividends. The risk adjusted annual outperformance of Amazon’s shares -- or its alpha -- was 13.37% over this period.
What was the investment thesis for Amazon in October 2008? At that time, the stock had a price to earnings (P/E) ratio of 46.7 -- more than double the S&P 500 average of 23.2. Also of note are the much lower valuations of its competitors Ebay and Walmart, which both had P/E ratios below 20 at the time. But underlying this stratospheric P/E ratio was a solid growth story. Over the previous two years, Amazon had seen sales growth rates of 26% and 29%. In addition, its margins were consistently over 25% during the reported periods.
In contrast to this seemingly elevated valuation, a savvy investor would have noticed the very strong cash flow trend as reported in its annual report (figures in millions):
- 2007: $ 1,181
- 2006: $ 486
- 2005: $ 529
- 2005: $ 477
This is the kind of strong trend that establishes the fundamental strength of the business. People who bought in during 2008 would have been delighted to learn that the cash flows continued to rise, and by years end had reached a reported as $ 1,3 billion.
Would you have pulled the trigger on Amazon in 2008? At that point, it was 14% down since the beginning of the year. By November 20, its shares had plummeted even further, losing 56% of their value. With strong fundamentals but evidence of an inflated value, it's likely that many investors who did take the plunge in October ended up jumping ship the next month. If there's a lesson to be learned here, it's to never base your investment decision on one metric alone (for e.g. a P/E ratio) and to not allow short term volatility distract from your long term investment thesis.
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