We are back with a great conversation about Amazon. The everything store and cloud giant is firing on all cylinders. Has new CEO, Andy Jassy, finally set Amazon up for sustainable profits going forward? Tune in and find out…
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Podcast Transcript
Barry
You. Hello, and welcome to the Long-Term Investing Podcast with Baskin Wealth Management. I’m Barry Schwartz, chief investment officer. Baskin Wealth Management is an independently owned investment management firm with almost $2 billion in assets under management, providing customized wealth management solutions and services to families and foundations. In this podcast, we ignore all the noise and have conversations that make sense about the things that matter in today’s markets. It’s what we talk about with each other here in the office, and we want to share those conversations with you. Please stay tuned for our legal disclaimer at the end of the episode.
Welcome back to the podcast. Ernest Wong joining me today. Ernest, how are things going with you?
Ernest
Going great.
Barry
Very good, I’m doing okay, too. Ernest, we wanted to talk today first about quarterly earnings and 13F season. For those that don’t know what a 13F is, it’s not your shoe size. It’s every quarter, companies that manage money – hedge funds, investment managers – must report their holdings, their US. holdings, if they manage more than $100 million. And so, you really get a glimpse into what maybe some of your favorite investors have been buying or selling during the quarter. So, for example, Warren Buffett’s Berkshire Hathaway has to disclose the trades that it made during the quarter, and everybody gets all excited because people want to see what other investors are buying. Everybody loves confirmation bias. Ooh, they bought something that I already own. Wow, I’m a genius because I bought it before them. Oh, no, they sold what I own. What should I do? And so, Ernest, looking at 13F’s, do they add any value to investors? What can we learn from looking at a 13F?
Ernest
I think it certainly can be fun to see what other famous investors are looking at and what they’re buying. But I think it’s largely a waste of time and probably useless for a variety of reasons. Number one is that it just provides you with a snapshot in time. It doesn’t tell you what the investor has done since the disclosure of the position.
Barry
So, let’s give an example. So today it’s August 18, whatever it is. And so, investors are disclosing the trades that they made from March or from April 1 to June 30. So, months ago, you don’t know if they made the trade in April or June and what the rationale is… and now it’s August. They may have sold that investment.
Ernest
Exactly. So that’s number one. Number two is that the 13F only shows you what positions they own and, which is, in many cases, an incomplete picture of the investor’s portfolio as a whole. So, as one example, there might be a situation where the investor, they owned the stock as a hedge for something else. For example, let’s say they bought an oil stock because they thought it was a good counterbalance to a short position that they had somewhere else. So, you don’t have that piece of information and so, without knowing that, you don’t know why the investor owns that position.
Barry
You just see the trades or the positions that they make, but the investor is not telling you the thesis, giving you the explanation behind the move that they made in that quarter.
Ernest
Exactly. And then the third is just broadly there’s a saying that you can’t borrow conviction. At the end of the day, you have to be comfortable with what you own in your own mind. Buying what other people have bought, even if it’s Warren Buffett, generally doesn’t work as well because we’re not Warren Buffett. Again, we don’t know why he owned it, and we are more likely to overreact if we are just blindly copying other investors.
Barry
And when I think about, for example, the Berkshire Hathaway 13F report, they own a lot of Apple. So, if he trims Apple, like Warren Buffett has 50% of his portfolio in one stock in Apple, that’s not really meaningful for you because you probably, as an investor, at least we do for our clients, we don’t put 50% of our portfolio into one stock. So, there’s so much more that goes on into portfolio management – position sizing – as you mentioned. The 13F only shows U.S. holdings, so, if investors also own, I don’t know, Canadian investments or European investments or Chinese investments, they may not appear on those 13F’s, so, you can’t learn a lot. I think maybe you can learn from those that are very concentrated investors or investors who had long term convictions on stocks and it could be interesting to see, they’ve held Google for 15 years, and then this quarter they decided to sell it. So, that could be interesting to learn from that, but if they’re not going to disclose to you in a shareholder letter or fund letter why they did what they did, not sure what you can learn or what you should do with that information anyways.
That said, we love looking at 13 F’s, and definitely the one that I look at most is Warren Buffett’s. When he does buy something, he tends to be quite a long-term investor and so interesting to see the moves that he’s making. But of course, Warren Buffett, as we’ve talked about, also has two other investors that work with him, Ted Weschler and Todd Combs, and they also make investments as well on behalf of Berkshire Hathaway. So, you never know if it’s Warren Buffett making the investment or Todd or Ted purchasing the investment.
Ernest
I’m not sure whether that matters.
Barry
Yeah, true. It’s all for the same company anyways, right? Yeah, fair enough. So that’s a little bit about 13F’s. Ernest, what do you want to talk about next?
Ernest
We talked about Apple last week, so I thought it’d be a good idea to continue on the big tech theme and talk about Amazon, which is another one that we own.
Barry
So that’s our feature conversation for today, which is Amazon, another gigantic big tech that made a gigantic move, I guess a week ago or so, two weeks ago when it released its earnings. New CEO, Andy Jassey, he’s taken over and he was in the hot seat, of course, because filling the shoes of Bezos, who’s now doing other things, it’s not easy, but I think he’s clearly creating his own path and so far, shareholders have been rewarded by Andy Jassy. So, let’s get into it. Amazon.
Ernest
So, I think most people are very familiar on a day-to-day basis with Amazon’s retail business, the one place where you buy stuff and get it shipped to your door in one day. I think maybe what’s a little bit less familiar to most people is that Amazon actually has the largest cloud infrastructure business in the world, too, called Amazon Web Services.
Barry
They’ve been advertising that a lot on TV, definitely on Canadian TV, you’ve seen them advertise. I was watching TV with my wife, and she’s like, why is AWS putting on ads? Why is that important to me as a retail person? I don’t run a business. Why do I care that Amazon powers the cloud anyways?
Ernest
What’s interesting is that Amazon actually invented cloud computing by launching Amazon AWS in 2006 and today, AWS makes up about roughly a fifth of Amazon’s revenue, but most of Amazon’s profit. The way this business works is, basically, Amazon has spent about $100 billion over the last decade or so on computers and servers that you can rent out. The reason that this has been so successful is because it’s a lot cheaper and more scalable if you’re a small business and you don’t have to manage your own computing infrastructure structure.
So, I think, just to put this into a simple example like Netflix. Netflix is one of AWS’s largest customers. Instead of having to spend billions on servers for the content that it makes, Netflix is simply hosting all of its shows on Amazon servers. And this is great, because if more people want to watch Bridgerton or, pick your Netflix show, Netflix can simply scale up its AWS usage. It doesn’t have to go out and buy more servers.
Barry
Which would cost a fortune for Netflix. It would never be profitable in its life if it had to build out its own data centers to host shows for streaming.
Ernest
And, today, there are three main cloud providers in the world, which are Amazon, Microsoft Azure, and Google as a very distant third place. And even though it’s a pretty competitive business, both Amazon and Microsoft earn decent margins and returns on these cloud businesses. Last year, AWS made about $22 billion of profit, and it’s a fast-growing business. They’ve doubled revenues and profits over the last three years.
Barry
So, Netflix is always producing more shows, buying more shows so, the more content, the more hours of video streaming, the more customers they have means they’re paying more rent to Amazon. Like a toll road.
Ernest
Exactly. So, Amazon historically has focused more on the technology sector. So, think of companies like Uber and Airbnb and Netflix, they all use AWS to some extent. And as these businesses grow, they naturally will use more AWS.
Barry
So why would Netflix choose Amazon over Microsoft Azure, or Google cloud? Is there a selling feature for one over the other?
Ernest
There has historically been a view that it’s a commodity service and that at the end of the day, you’re just going to go with the place that’s going to sell you computing power for the cheapest. But I think over time, what has happened is that well, first of all, it’s really hard to make a new cloud computing service just because of the amount of money that you have to spend. And that’s even before all the technology that goes into it. Amazon has spent over a hundred billion dollars on servers, I don’t think there’s many people or companies in the world that have that kind of money.
Barry
No, you and I aren’t going to go into the server business.
Ernest
Yeah. And to make a competitor that successfully competes, it has to be mostly global because otherwise there’s no point in using a cloud provider. Let’s say you wanted to expand into Latin America, you’d have to go and buy your own servers. That wouldn’t make any sense.
Barry
So, you need to use a company that has global scale, that has the most servers, that has the least downtime, the most efficiency and so, you’ll choose based on pricing, but it’s always best to go with the biggest and the best.
Ernest
And over time, the cloud providers have also been adding more features. Things like security, things like more recently in AI training, and these kinds of things like extra services to help their customers as well. So, these are a pretty big chunk of the revenues.
Barry
So, let’s say Netflix has made a contract and engagement with Amazon to use AWS. Once it’s put all its data up, there are billions of hours of information. Can it ever leave and go to Microsoft?
Ernest
It’s not impossible, but it’s difficult. First of all, it would take a lot of time and there would be risk to doing so because of potential issues during the migration. But secondly is that Netflix has a team of people managing their AWS infrastructure then to figure out a way to manage that as well.
Barry
Sounds like a pretty good business, Ernest.
Ernest
Yeah, in recent years they’ve gone through a little bit of a slowdown in growth, but it’s still a very profitable business with a very long runway of opportunity.
Barry
Yeah, I always find that funny when the market gets upset about decelerating growth. Those are two words put together that make not a lot of sense to me. No company or no business line is going to grow forever, but if you’re still growing and you’re growing at high teens percentages, like a lot of these cloud companies, that’s still excellent. And as they get more revenues, as you said, it’s a very profitable business line. So, a lot of those revenues flow right to the bottom line as extra profit.
Ernest
And the opportunity is still very wide.
Barry
Yeah, talk to us about that.
Ernest
Globally, over 90% of all infrastructure spend is still on premise, which is like servers within that you have to manage yourself.
Barry
So that’s our business, Ernest. We were server based, we’ve moved a good chunk of it over the last year on to Azure. Sorry, not AWS, but our clients also own Microsoft, so we win there. But we still have some legacy stuff in house that we have to move, and it’s not easy, and we’re in the business of managing portfolios, so we have to find the time and find the right company to transition us, and we’re not the only company that is still in transitioning, moving stuff to the cloud or haven’t even thought about it. So, I think that’s an excellent insight. It’s just really in the first inning of cloud transition.
Ernest
Yeah, so, the cloud business makes I think the important takeaway is that the cloud business is growing fast and makes up most of Amazon’s profit. So now the retail business, just to give some sense of its size in the US today, ecommerce is about 15% of all retail sales. It varies a bit by category.
Barry
There was a big step up during COVID obviously, right?
Ernest
Yes. It depends a bit on the category. Like toys and books are essentially 90% ecommerce, but across all categories, 15% is the right number.
Barry
Well, yeah, I mean, clothes or running shoes. I have two boys and you have young kids, too, their feet grow tremendously. They wear out their shoes, they play sports. We’re not going to stores to try on shoes. She’s just ordering them online through SportsCheck or Footlocker or Nike. And if it doesn’t fit, send it back for free and get another pair. I mean, it’s easier than wrangling the kids to try to get them to the mall.
Ernest
Yes, and so, of this 15%, amazon has about 40% market share in the US. So even though it feels like you’re buying everything on Amazon, in reality they just have five or 6% market share of US retail sales, so, still a lot of runway to grow, even just in selling stuff.
Barry
There’s still a lot of holdouts who are not comfortable putting in their credit card online. They haven’t used an Amazon Prime account. My parents don’t have their own Amazon, but I’ve ordered things for them. Amazon doesn’t care if I order things to their house. They’re happy it’s another sale for them. But over time, more people will get comfortable. I know my in laws finally got comfortable going on to Amazon and ordering stuff on their own. So still early days for ecommerce.
Ernest
As a side note, that’s the reason why I think Amazon is not going to go down the Netflix route of cancelling or forcing people to get their own prime subscriptions because they want you to share your password because the money is not made in the $15 Prime subscription.
Barry
Well, like, think about Costco, right? If Ernest has a Costco membership, you go to the store and you’re the only one that can buy and pay for it. But you’re allowed to buy stuff for your parents. You can buy stuff for your friends at Costco. You’re not forced to only buy stuff for you. So, I think you’re right that’s probably the right model for Amazon is they won’t be kicking people off Amazon Prime, but, you know, the shows are not that good. Let’s get back to Amazon retail.
Ernest
So, the retail business has gone through a few changes ever since Bezos started selling books on a website. The first is the launch of Amazon Prime, which 60% of Americans are Amazon Prime members.
Barry
Wow, that’s huge. And how much are they paying a year? $100.
Ernest
Well, it’s $15 a month in the US, but what this does is that you get same day or one day free shipping, depending on where you are. With a bunch of, like you said, mediocre shows and Amazon music, and there’s, like, a whole list of perks that you get.
Barry
Does anybody use Amazon Music or Amazon Podcasts or Amazon Photos?
Ernest
Probably, but I think the key to thinking about Prime is that you don’t feel any pressure or friction in completing the transaction. No, because it’s free shipping.
Barry
Free shipping is a game changer for all of us. I wanted to order something from Canadian Tire, the great Canadian retail store, and like, $12 to ship. I’m like forget it. I’ll just find the same crap on Amazon for free shipping because I’m already paying for Amazon Prime.
Ernest
And this Prime has really supercharged the amount of stuff that people buy on Amazon. Just because you don’t have to pay for it.
Barry
Right, you don’t have to pay for the shipping.
Ernest
Yes, you don’t have to pay for the shipping. So that’s number one. Number two is that, historically, Amazon acted like any other retailer. Let’s say you wanted to buy toothpaste. They would go to Colgate. They’d buy the toothpaste from Colgate, they’d list it on their website, and then they’d ship it to you. I think, over time, what Amazon realized was that this really limited the amount of things they could sell on their website.
Barry
They can’t store everything in their warehouses.
Ernest
No. And nor can they establish a relationship with every single supplier that exists. So, what they did was they created a marketplace where sellers can list what they want to sell without Amazon ever buying it from you. Amazon will help you ship it. They’ll store it in their warehouse, and you can buy it on Amazon.com. But Amazon never gets inventory of the thing. They never have to pay you for it, in essence. And so, today this is called Third Party Seller Services and the service is particularly called FBA – Fulfillment by Amazon. And what this has done is that it really opened the amount of selection that you can buy on Amazon both in a good and maybe not so good way. But third parties today make up 60% of all the things that are sold on Amazon, and it continues to grow. So, this is the second change to Amazon.
Barry
Yeah. Many people complain that there’s too much selection on Amazon and unsure of the quality and are the reviews true? But I’d rather have too much selection know just one option and then not price compare, and review compare.
Ernest
Well, I think one thing, that to your point, is not very well appreciated about both Amazon and most tech companies in general is the amount of data that they have that they can do testing for, and tech companies test everything. They the color of the fonts that they use, where the picture of the product is placed. They’re always testing to see how the customer or the person looking at it is going to react. And so, Amazon has big things such as third parties they’ve done extensive testing to see, well, are customers just overwhelmed by the selection or do they actually like having more things on sale?
Barry
And of course, you can pay extra to have your product listed at the top or sponsored by Amazon. Lots of different ways that Amazon can rate the sale.
Ernest
And this brings to the third point, which is that Amazon started selling ads. There is an interesting story about ads which I think everybody kind of intuitively hates ads for whatever reason, but within Amazon, they started to debate whether they should sell ads. Some people felt that it would degrade the user experience, while others felt that there was so much financial upside to selling ads that they should do it. And so, again, after testing the user response, Bezos decided that the financial upside from selling ads was so great that even a mild decrease in user satisfaction was worth it, and so that’s what they did, they started selling ads. And it’s a very big business today for Amazon.
Barry
And I imagine mostly profit business. High margin business is what I’m trying to say.
Ernest
Yes, and so that’s where we are with Amazon today. Subscriptions like Prime fees, third party seller fees, and ads make up 60% or so of the retail business’s sales. And this continues to grow.
Barry
Because they don’t make a lot of money shipping you that one tube of Colgate that you bought for probably slightly more than you would if you bought it at the grocery store. You’re paying for convenience, obviously. But Amazon’s not making big bucks on that.
Ernest
No, and these are all high margin revenue streams that are very profitable for Amazon that continue to grow by double digits even after COVID. But the big issue for Amazon over the last year or so has been on the cost side. During COVID everybody was stuck at home, everybody ordered everything on Amazon, and Amazon had to expand its shipping capabilities and warehouses significantly so they could meet the demand. Last year they faced the double whammy of, number one, slowing ecommerce demand as people started to go back out to stores, and then secondly, from inflation. Inflation for things like shipping, for labor.
Barry
And also, people bought a lot of stuff that they needed. They didn’t need to buy those things again for a few years so the demand was slowing.
Ernest
So, you add those two things together and the retail business actually lost money in 2022.
Barry
Never been a high margin business to begin with anyways, but that was really shocking to people. How can Amazon be losing money on retail when everybody’s at home ordering stuff? And clearly the trend’s going only higher, but it can’t make a lick of money on its retail business.
Ernest
Yeah, so I think they realized that there was a problem. Business wasn’t growing as fast as it was so, they’ve done a bunch of stuff to cut the cost structure, make it more efficient and they are making money again.
Barry
Yeah, I mean, they’ve laid off a lot of people, unfortunately. And they’ve stopped growing or building warehouses, looking to release some warehouses, stop some development. Everybody thought some of those trends during COVID would be extrapolated dramatically higher, and luckily for the world, things have normalized. But that doesn’t mean Amazon isn’t going to grow from here.
Ernest
Right. I think, as with many companies, I think during the low interest rate environment, they spent a little bit more than they should have on things that they probably not going to make the money for a while. There was an old story from a long time ago when Jeff Bezos would force his employees to pay for coffee and he himself would line up to pay for coffee inside Amazon. I think they’ve gotten away from that culture a little bit, aut today I think Amazon is very well positioned. Nobody is going to build a fulfillment network to the same scale that Amazon has, that can ship anything to your house within one day.
Barry
I think Shopify was trying, but it ended that very quickly. Seeing the escalating costs and slowing. How can you compete against Amazon?
Ernest
Yeah, so recently there’s been buzz about a Chinese competitor that they would be cheaper than Amazon but take like two weeks to ship to your house. But I guess we’ll see where that happens,
Barry
It’s not going to work for my family, I don’t know about you.
Ernest
I think Andy Jassey came out as the CEO and very strongly said they’ve done testing and people really do value fast shipping.
Barry
100% they do. My son just came home from camp for six weeks and he eats a lot of cereal and oat milk with his cereal. And I ordered oat milk last night from Amazon, and here it was this morning and we got twelve containers of oat milk. It’s not something I would go pick up at the store. It’s too heavy, it’s crazy. And I certainly wouldn’t want to wait two weeks for it to come from China. And I don’t think I would have wanted to drink oat milk from anyways. That’s not the point.
Ernest
Yes, so, long term, I think I’m very confident that they’re going to continue to gain market share in ecommerce, which is itself gonna be more important going forward. I think it’s not a bold prediction to say that you’re going to be spending more online rather than in person in the future.
Barry
So, what are the risks of Amazon? Because we always see everybody talks about regulation and antitrust. Is that a big concern for you, Ernest?
Ernest
I think it’s hard to say. First of all, Amazon, if you look at how they conduct their retail operation, it’s still smaller than Walmart and Costco, right? I don’t know about Costco, actually.
Barry
No, I don’t think it’s smaller than Costco, but yeah, definitely much smaller than Walmart.
Ernest
Yeah, so there’s certainly not a monopoly by any sense. And the second thing is that most of this has been organic growth. Now I think recently there’s been a little bit of buzz about whether they were forcing you, making it hard for you to cancel prime.
Barry
But I think every company makes it impossible for you to cancel everything so they’re not just the only bad guy in that.
Ernest
And I don’t think that really matters. I’m not spending on Amazon because I can’t cancel it, I’m shopping there because it’s fast and convenient.
Barry
Because I get that oat milk the next day. So, the knock against Amazon for years was the profits. Where one year would have good profits, then the next year would be spending like crazy or expanding, and then no profits. And the dream was always, one day those profits are coming. They’re coming, and I don’t want to say that based on one quarter that that’s the case, but it definitely looks like those sustainable profits are now here. What’s your take on that?
Ernest
I think the most important thing about Amazon is that, over time, they’ve gone from two-day shipping to one day shipping and same day shipping. The management has basically come out and said they’re not going to go to same hour shipping for everything. So, the rise in shipping costs over the last few years is coming to an end. And today, now that they fixed the cost structure from COVID, it’s all about growing the volume and scaling up, and I think margins are going to go up, I think a bit stronger than what people are expecting.
Barry
And didn’t Andy Jassey explicitly say that he’s going to control costs going forward?
Ernest
Then keep in mind again, that this is just the retail business, where the cloud business is growing spectacularly as well.
Barry
And of course, there’s other irons in the fire for Amazon. It’s logistics business, it’s business to business as well, that’s just getting started. There are so many lines of profits that Amazon can continue to build out here as it continues its world domination. So, we own the stock, our clients own the stock. I own it personally. Ernest, do you think it’s an attractive opportunity here? It’s certainly moved up from low prices in December, but still well off its all-time high.
Ernest
I think so. I think if you look at the big picture, they have two very dominant businesses. I think the management has clearly said that they’re going to focus on costs going forward, so every additional revenue that they gain is only going to be very profitable for them.
Barry
That would be the dream. And for shareholders, and certainly the market is starting to hope that that is a sustainable path for Amazon going forward. Any final words on Amazon?
Ernest
So, anybody who is interested in learning about Amazon’s culture, about Jeff Bezos, there’s two books that I can recommend.
Barry
Oh, great segue for the book recommendations.
Ernest
Amazon Unbound is the more recent one. And the Everything Store.
Barry
The Everything store is a fabulous book. Amazon Unbound was a little bit all over the place.
Ernest
They were both written by Brad Stone, who did a lot of work studying Amazon.
Barry
Excellent books – and, after reading it, I did not own the stock before that, but after reading the book, it really changed my mind. I like reading long form books about companies, I think that to form a thesis, instead of reading an analyst report or 500-word blog.
Ernest
I also find that the investigative journalists like the guys from The Wall Street Journal and Bloomberg and those kinds of places, tend to write the best books. Books that are written by the founders, there are exceptions, but they tend to be like, oh, I’m a genius, I did this, and it worked out spectacularly, and I’m the greatest guy in the world. Whereas journalists, first of all, tend to be great writers, and then second of all, I think they tend to provide a better perspective on the situation as well.
Barry
Very good. Great book recommendations. Thank you very much for joining us. We’ll see you back here real soon. Take care.
This podcast is for informational purposes only and any forecasts on the economy, markets or individual securities should not be viewed as investment advice, a recommendation, or an offer or solicitation to buy or sell any securities. Clients of Baskin Wealth Management and the speakers on this podcast may own shares of the companies discussed. Information on this podcast is current as of the time of production and is subject to change. If you have any questions or would like to subscribe to these podcasts, visit our website@baskinwealth.com.
