What is AWS worth? Thoughts on the business and whether it should remain part of Amazon $AMZN

As cities across the U.S. embarked on huge marketing campaigns to attract “HQ2”, I couldn’t help but ask myself why Amazon was planning a second headquarters. Usually companies like coherence and for the business to act as one under one roof. It is more difficult to do this when you have two “headquarters”. To me, it reminds me of having two CEOs. Two voices. Two cultures.

I came to the conclusion that Amazon was preparing for a split up of the company. The traditional retail business + Whole Foods would go under one umbrella and continue to operate out of Seattle, while the second business would be Amazon Web Services (AWS) and would operate out of its own hub and have its own resources.

For those that do not know, AWS is much different than the retail business. It is designed to provide developers quick access to on-demand computing power, storage, applications and development tools at low prices. Thanks to its offering, developers, startups and other companies do not need to focus on infrastructure build out when they are starting a new venture, they can instead focus on their core product and utilize AWS’ resources. This allows faster speed to market in some cases. It also allows this spend to be a variable cost, rather than a high, upfront capex spend.

This led me to ask myself:

  • What do I think AWS is actually worth? Does Amazon’s valuation today reflect its strength?
  • Is AWS actually a good business?
  • Would splitting the company make sense?

I think I am going to go through the answers in reverse order. I do think it makes sense to split the company. AWS operates in a competitive environment with the Microsoft Azure, Google Cloud, IBM among others clamoring for a larger piece of the pie. AWS currently has top share of wallet, but it’s a much different business model than the retail business. Here are my three main reasons for splitting the company:

  • Allow focus in areas of strength.
    • Being a company focused on one goal helps keep all employees realize what the goal at the end of the day is: support customers.
    • Today, while a smaller part of the market, there is a conflict of interest with AWS and CPG sectors (e.g. Target announcement to scale back AWS, Kroger announcing post-Whole Foods it would be moving to Azure and Google)
    • Typically in conglomerates, new business in certain sectors can go unnoticed or underappreciated as “approvers” up the chain of command have other things on their priority list. Splitting the company reduces this kink in the chain. This appears to be limited risk today as Amazon is growing AWS and its services, but think about the other segments. Perhaps they are moving slower now in the retail segment or internationally than they otherwise would.
  • Optimize capital allocation
    • AWS is highly profitable from a EBITDA perspective (though is also highly capital intensive today as it grows). On the other hand, Amazon’s retail business is not only low margin, but also is capital intensive and its return metrics are much lower than AWS (especially internationally where the company still has significant operating losses).
    • Even if I think returns for AWS will come down over time (discussed more below), you could view the company as funneling good money after bad (i.e. taking resources from a high return business and pushing it into low return business). If I invest $1 dollar into AWS, I get 28 cents back in year 1 compared to 9 cents for North American retail or losing 11 cents Internationally.
    • You may be optimistic about the LT trends in the retail business and its improving profitability over time, but think about if AWS could funnel more of its cash into higher return projects. It is likely to perform better over time on its own. Freeing up these resources can help AWS invest in its core capabilities and build sustainable competitive advantage.
  • Better align incentives
    • Distinct and clear business with their own performance goals matter when you are paying your employees in company stock
    • Imagine you are a leading employee in the field and asked to work for Amazon. A significant portion of your comp will be in restricted stock that pays out if the entire company does well. But oops, something happens to the grocery business at amazon and the stock falls 20-30%, so now you are well out of the money.
    • Wouldn’t it be better if your performance and the company’s performance were linked?

Is AWS a good business?

“I believe AWS is one of those dreamy business offerings that can be serving customers and earning financial returns for many years into the future. Why am I optimistic? For one thing, the size of the opportunity is big, ultimately encompassing global spend on servers, networking, datacenters, infrastructure software, databases, data warehouses, and more. Similar to the way I think about Amazon retail, for all practical purposes, I believe AWS is market-size unconstrained.”

-Jeff Bezos, 2014 Letter to Shareholders

Clearly, AWS has grown like a weed. Amazon has disclosed the results of this segment going back to 2013 and we can see sales and EBITDA have grown at a ~50% CAGR since then and 2018’s pace actually picked up over 2017.

The business started when Amazon brought infrastructure-as-a-service (IaaS) with global scale to startups, corporations, and the public sector. By this, I mean that they provide the infrastructure that allow these companies to outsource computing power, storage, and databases to Amazon. It essentially turned this services into a utility for consumers, with pay-for-what-you-use pricing models.

As stated earlier, this allows customers to add new services quickly without upfront capex. Businesses now do not have to buy servers and other IT infrastructure months in advance, and instead can spin up hundreds of servers in minutes. This also means you benefit from the economies of scale that Amazon has built up. In other words, because Amazon has such massive scale, it can pass some of those saving on to you. If you bought the servers and other utilized ~70% of the capacity, your per unit costs would be much higher.


AWS has attracted new entrants as well. Microsoft’s Azure and Google’s Cloud have also grown and attracted share. Microsoft provides some color on the business, which I have estimated in the table above, but Google provides basically no disclosure. Other players with smaller market share include Oracle, IBM and Alibaba in Asia.

Despite growth in Azure, Amazon owns more market share than the next 4 competitors combined. And the rest of the market appears to be losing share.


The logical outcome from this, especially when considering how capital intensive the business is, is that the business forms into an oligopoly. Oligopolies traditionally have high barriers to entry, strong consumer loyalty and economies of scale. Given limited competitors, this typically results in higher prices for consumers.

However, this is not always the case and it leads me to some concern on the industry. In some cases, oligopolies become unstable because one competitor tries to gain market share over the others and reduces price. Because each firm is so large, it affects market conditions. In order to not cede share, the competitors also reduce price. This usually results in a race to zero until the firms decide that its in the best interest of all players to collude firm-up pricing.

How could this happen with Amazon Web Services? Well, we all now Amazon’s time horizon is very long and it attempts to dominate every space it is in by capturing share with low prices. As said in its 2016 letter to shareholders:

We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions.

Jeff Bezos, 2016 Letter to Shareholders

In addition, other competitors have benefited from movement into the space and have been rewarded in their stock price (see MSFT). Ceding share to AWS may hurt their results (and stock price) so they may attempt to take more and more share at the expense of future returns. In a way, what could happen here is more of a slippery slope. They give a bit on pricing because the returns are so good now that a small price give here and there want matter. But then they add up…

Lastly, its no secret that building data centers to support growth is capital intensive (see AWS financial table above). They also serve a lot of start-ups and other businesses. This creates a large fixed cost base for the cloud players. If there was a “washing out” of start-ups, such as the aftermath of the tech bubble, AWS and others could see excess capacity, hurting returns. In order to spread the costs, they may attempt a “volume over price” strategy. This will result in retained share, but hurt pricing for the industry as competition responds.


Unfortunately, I DO think returns are going to come down materially over time. The industry reminds me too much of commodity industries. The industry is no doubt growing today, but the high margins we see today I believe are from high operating leverage. This tends to be more transitory in nature and means that returns on incremental capacity invested go down over time.

Take for example commodity chemical companies. AWS reminds me of some of their business models (unfortunately). Some operate in very consolidated companies, but operate at very high fixed costs and have exit barriers. The loss of one customer results in very painful results due to operating leverage. Although higher prices are better in the long run, the company will lower price to keep the volume and keep the fixed cost leverage. Think about commodity businesses that report utilization (note, we have limited disclosure on AWS, but that might be a helpful statistic in the future). Higher utilization usually results in good returns on the plant (or in the case of AWS, server). However, when you lower price on the commodity, the competitors, in turn, will also lower price so they don’t lose their existing customers. What results in lower returns for everyone.

As a another case study, P&G used to run its HR, IT and finance functions within each of its business units. It decided to form one, centralized, internal business unit to gain economies of scale. It actually formed a leading provider of these services. But then, P&G looked at its core business and said, “do I need to continue doing these functions or can I outsource it? Or maybe I can sell this whole business unit to another provider, which would give them more scale and lower the cost of the function”. The latter is what ended up happening. Although it wasn’t viewed as a commodity at the time, these functions began to become more commoditized and business process outsource companies (“BPOs”) now have very high competition and lower returns.

Another analogy would be to at the semi-conductor or memory businesses, though perhaps not as commodity as these two.

I personally think that over time, we will see this form with AWS. The fact that pricing has come down so much for the service (one unnamed engineer I interviewed told me that AWS will even let you know if they think pricing is coming down soon to keep your business). According to the Q3’18 earnings call, Amazon had lowered AWS prices 67x since it launched and these are a “normal part of business.” They’ve certainly been able to lower costs as well so far, but how will that change as competitors also gain scale?

How could I be wrong? I could be wrong in many ways, but the one case is that I am underestimating how “entrenched” the business is into everyday use. That could result in very low switching by customers. It could also mean that developers get trained using AWS so default to using its services. The counter to these arguments is that there is a price for everything and clearly Azure has taken share over the past year, so it’s not proving out thus far.


So is it a good business? Well, lets look at at it from a Porter’s Five Forces perspective. I think the view on these, in brief, plus the current returns we can see in the previous tables would point to the industry being solid. My one concern comes back to the competitive rivalry. We can have a high barriers to entry business and highly consolidated, but returns are not good.

What do you think AWS is worth?

Based on the market share numbers posted above, AWS is currently attacking a $73BN market. At the rates that the market has been growing, as well as the additional services, I think its reasonable the market expands to $100BN in the near term, especially as adoption increases. I assume Amazon maintains its market share due to its relentless focus on lowering price and maintaining share. I think the additional share gained by Google and Azure will come at the expense of the other players included in the market share chart above.

For the reasons stated above, I think this results in returns coming down over time. I still model good returns to be clear, but that the return on assets comes down meaningfully.

This may be hard to read, but I end up with a valuation of $164BN for AWS. Given the value of AMZN today is around $830BN even though AWS accounts for over half of EBITDA now, I cant help but think this opportunity is more than priced in, unfortunately. However, I maintain that the business would benefit in the long-term from being on its own for the reasons discussed above. In the short-run, it may get a higher multiple than the rest of the Amazon retail business since its growing quickly with such high margins.

Will Exxon Need to Cut its Dividend? $XOM

Saudi Arabia and Russia are in a price war — increasing the supply of crude oil at a time when we are seeing an unprecedented collapse in demand due to the coronavirus (COVID-19). Exxon has gotten crushed this year, down 45% YTD with a 9% dividend yield. They’ve consistently paid, and grown, the dividend over the past 37 years. That’s a juicy proposition for a company that is rated investment grade and at a time when the 10 yr treasury yield is <70bps.

But let’s do some quick math to see if the dividend is covered, first by looking at 2019 figures. As shown below, Exxon did $1.5BN in FCF.

This is not good. Exxon spent $14.6BN on dividends in 2019. One thing we could do is look at what bare-bones capex is. In other words, what did the company spend in 2015/2016 when the oil outlook was also bleak? Cutting capex down to those levels would help preserve cash:

So now we have ~$10.5BN of FCF, but that still doesn’t cover the dividend. The other problem is that cutting capex is not what the company wants / intends to do. As stated in their March 5, 2020 investor day, they will actually be spending more than 2019:

Sure, they leave an out to lower capex, but this was the beginning of March so we already could see the demand destruction. I will say, this was a few days before the price war. Even so, cutting capex back doesn’t help. And the bigger problem is that oil was roughly 100%-200% higher in 2019 than it is right now.

Exxon could sell assets to help cover the dividend, or increase its debt load, but is that really what you want in a commodity industry?

I think its a matter of when, not if.

4 Businesses Buffett Could Buy $PPG $TJX $GRA $BECN

Buffet is sitting on a cash hoard, but has been quiet so far in the market sell-off surrounding COVID-19. I wanted to run through companies I think Buffett could realistically buy. I may surprise readers in that these are not “elephants”. Here’s my rationale for that:

  • Why does Buffett have to spend all of his cash position on one position?
  • He prefers not to deal with auctions or hostile takeovers. Large boards can’t say they’ve done their fiduciary duty by just selling without running a wide process. Smaller companies might be able to if its a fair first offer or because they don’t expect any competing bids in the current environment.
  • Smaller companies have larger growth runways. Many of the names I list below are strong competitors in a fragmented space, which means they can consolidate and outgrow GDP.

PPG: $20BN market cap, $24BN Enterprise Value

  • Business Description: sells coatings (i.e. paint) for a wide variety of end markets such as house paint, aerospace, industrial and automotive refinish
  • Why buy? Paint is a very attractive business model. Consolidated business with pricing power because paint typically is such a low cost of any project. The space is still somewhat fragmented, so there is roof for more acquisitions, but outside of that the paint names are FCF machines. He already owns some Axalta as well, which PPG competes against in the automotive refinish space, but PPG offers so many other types of paint as well.
  • Why now? PPG does have industrial and aerospace exposure, which likely will take a hit due to coronavirus. However, you are buying a great franchise at a fraction of the price of Sherwin Williams.
  • What’re you paying for it? Right now, PPG trades at 12.3x 2021 EPS (SHW trades at 18x) and nearly 8% FCF yield. That seems too cheap for an above-average business.

WR Grace: $2.5BN market cap, $4.3BN Enterprise Value

  • Business Description: makes catalysts which produce chemical reactions.
  • Why buy? Catalysts are high-impact technology. In refining, if I want to upgrade a barrel of crude to make the highest-value product, catalysts can help with that. Similarly, they are used to make plastics like high-density polyethylene. There are very few producers, its impact and low-cost relative to operations leads to consistent pricing power, and relatively asset-light leads to high returns on capital. Also, Todd Combs made a fortune on WR Grace in the past and is now CEO of GEICO. No doubt he sees the price move as an opportunity.
  • Why now? Trades for the lowest multiple I’ve seen in a long time and its long-term business prospects will be fine.
  • What’re you paying for it? 7.6x 2021 EPS for a business that consistently earns 25%+ returns on capital

Beacon Roofing: $1.1BN market cap, $4.6BN Enterprise Value

  • Business Description: roofing distributor as well as other building products (wallboard, ceilings, etc) .
  • Why buy? Roofing distribution is a good business. Demand is mainly repair and replace driven and leads to very stable results (if your roof had a leak, it doesn’t matter if the economy is weak you are probably going to get it replaced… it may even be covered by homeowners insurance). While distribution is a low margin business, they earn high returns on capital as they don’t actually manufacture anything (so low capex) and sell a lot of product. The space is also highly fragmented so it could provide room to continue to roll up the roofing space as well as add in adjacent products where it makes sense.
  • Why now? Cheap.
  • What’re you paying for it? 9x 2021 EBITDA and 5.7x 2021 EPS. These are some of the lowest multiples ever for this company.

TJ Maxx: $56BN market cap, $64BN Enterprise Value

  • Business Description: off-price retailer
  • Why buy? Its a retailer, but has staying power. Costco has been described as “experience shopping” and TJX is no different. Returns on capital consistently exceed 30%.
  • Why now? TJX announced it would close stores due to the virus. Results clearly may be impacted. Perhaps Buffett doesn’t buy the whole thing, but TJX is a great business I could see him scooping up.
  • What’re you paying for it? Not super cheap at 16x 2021 EPS, but that’s a narrow focus for a company with returns on capital of that level.

Will Coronavirus Kill the New Media Tech Giants? $FB $GOOG

We’re all locked inside. And that means we’re all watching Netflix, shopping Amazon, and perusing Facebook & Instagram and googling places we wish we could visit. That means all of these companies will benefit from the virus, right?  Facebook and Google must be killing it with advertising revenue.

Facebook just put out this somewhat misleading press release. In a gist, it says app usage is skyrocketing…

But….

“Much of the increased traffic is happening on our messaging services, but we’ve also seen more people using our feed and stories products to get updates from their family and friends. At the same time, our business is being adversely affected like so many others around the world. We don’t monetize many of the services where we’re seeing increased engagement, and we’ve seen a weakening in our ads business in countries taking aggressive actions to reduce the spread of COVID-19.


Both Facebook and Google make money off of small-and-mid-sized businesses. While having a lot of users allowed them to begin charging businesses for ads, it doesn’t necessarily mean they are making money off all the users. More on that later.

The interesting thing about them is that they have been fast growing through the past ten years, but weren’t really around in the past. Therefore, the business model hasn’t really been tested through a real recession.

Advertising is cyclical. This makes some intuitive sense. When business is going well, you have extra funds left over that can be used for generating more sales. Or competition is higher because there is room for it and so you need to maintain market share. YOU may even be the new entrant trying to gain that share.

In a downturn, cuts have to be made. If I am a restaurant, I can’t really sacrifice much on food costs or labor or else my customers may have a bad experience.  If I also have a feeling that consumers don’t really want to spend money right now (e.g. unemployment is going up) then why not cut my advertising spend? It ripples through the chain.

As the saying goes, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” This has historically resulted in cuts to spend since CEOs don’t feel like they are getting the bang for the buck.

Here is a snapshot of “old school” advertising companies’ peak-to-trough in the Great Financial Crisis (GFC).

Note, for the TV broadcasters I am using 2-yr average results given election years play a factor in results.

I also use gross profit given incremental margins matter so much in advertising. Quick Segway: If I have an existing network of 10 billboards in a town and 9 of them are on rent, you can see how getting that last billboard on rent would result in meaningful profit to the bottom line. My sales go up ~11%, but my costs barely go up. True in nearly all advertising and very true for Facebook and Google. Ok back to the main points.

What Can We Expect from the Tech Behemoths

I highly doubt many people are truly thinking about Facebook or Google’s earnings declining at all in 2020, but it’s something worth pondering.

Facebook on its Q4’19 earnings call stated there are now, “140 million small businesses that use our services to grow.” Google, in its filings, specifically discusses how its targeted ads let small businesses connect with customers.

If the virus ripples through our economy, taking down small restaurants and bars, local gyms, and people pull back on buying cars from their local auto dealer — that could clearly impact Facebook and Google’s results. With most restaurants closed right now, why would I advertise as much?

Unfortunately, it’s impossible to see where Facebook and Google make their money by segment. It’s much easier to know that Yelp generates most of its money from restaurants looking to promote themselves in a competitive field. Not true for the tech behemoths though.

We have some financial history with Google, given its IPO was in 2004. The problem is that it was secularly growing during the GFC. Google does $162BN of revenue today. It did $16.6BN in 2007 at the “market peak”. It kept growing through the GFC, though growth did slow to just 8.5% in 2009 over 2008.

Sell side estimates currently expect 16.7% growth in 2020 for Google… on much larger numbers. Facebook is expected to grow 20%. These may prove aggressive.

Impact from the Virus

I do not think it is out of the realm of possibility that we could see sales growth slow meaningfully for the tech giants. This will lead to a reset of expectations, though admittedly, the two ad tech giants trade for reasonable multiples (believe FB is 12x earnings ex-cash). My larger fear is the reset of investors’ view of the business as whole — they may no longer be bulletproof.

That said, if I am in charge of an ad budget, this may accelerate my shift away from traditional media and to Facebook and Google. People are at home, shopping online, then why not. Plus, its super-high ROI advertising spend. In other words, I don’t pay Google unless someone clicks on the ad, so I’m only paying if the ad works.

This dynamic may finally get rid of the adage I mentioned above – I now know if my ad is working. And because of this we could see more resiliency out of the new advertising names and it could be a bloodbath for traditional names. However, it still holds true that I’m not going to buy an ad, or at least as many, when I’m struggling to pay payroll or rent.

Separate Challenges for Google

Google has been expanding in the travel space, in fact encroaching on ground owned by Booking’s Kayak or Expedia. Booking said in its latest 10-K:

Some of our current and potential competitors, such as Google, Apple, Alibaba, Tencent, Amazon and Facebook, have significantly more customers or users, consumer data and financial and other resources than we do, and they may be able to leverage other aspects of their businesses (e.g., search or mobile device businesses) to enable them to compete more effectively with us. For example, Google has entered various aspects of the online travel market and has grown rapidly in this area, including by offering a flight meta-search product (“Google Flights”), a hotel meta-search product (“Google Hotel Ads”), a vacation rental meta-search product, its “Book on Google” reservation functionality, Google Travel, a planning tool that aggregates its flight, hotel and packages products in one website and by integrating its hotel meta-search product into its Google Maps app.

 This is a problem for Booking and Expedia because they use Google to generate leads for their own sites. While Google may eventually consume these businesses, they also represent non-trivial amounts of their revenue.

Booking stated,

 Our performance marketing expense is primarily related to the use of online search engines (primarily Google), meta-search and travel research services and affiliate marketing to generate traffic to our websites.

How much was “performance marketing” expense?  $4.4BN in 2019 for Booking and $3.5BN for Expedia.

I bring all of this up for a reason: While Google may eventually compete away these businesses, but today they matter. And those businesses are likely being crushed by the lack of travel demand right now, which will mean less spending with Google. These are just two companies, but ~5% of sales for Google. Now imagine every hotel chain, restaurant, airline and so on also pulling back… Now weave in the incremental margin we discussed earlier…


This virus is truly something we haven’t seen before. It permeates everything we touch. Long-term, I think Facebook and Google are amazing businesses to own, but don’t be surprised if 2020 is a hiccup and expectations are reset.

My playbook for “backing up the truck” in this market. Putting my buy-decision thoughts completely out there $SPY

I did a post yesterday on some data points to consider before buying in this market.  I’ve been nibbling on the way down, but looking at some of the data points, I have to agree with what Gavin Baker has said in a recent post: this is a tremendous demand shock that we have not seen the likes of before. It will be very difficult to navigate it this time because its almost like a 9/11 and a 2008 demand shock rolled into one (but not a financial crisis like 2008 was).

The market clearly priced some of this in. The chart below shows the Russell 2000 drawdowns in the past. We’ve already surpassed the drawdown of 2001-2002 and did so much more swiftly. If anything, this drawdown is looking like 2008 just from the slope of the line (its steep).

IWM Chart

IWM data by YCharts

The Fed has acted quickly, congress knows it needs to get its act together, Trump views the stock market as the best polls, proposals are coming together to give every American $1,000 to bridge the gap, and there is plenty of talk of bail outs. Seems like some lessons were learned from 2008… act fast.

But is that enough? Is everything “priced in”? How will the market react to new information of cases vs. stimulus? That’s a billion dollar question. Personally, I think we have further to go before I can say we all need to “back up the truck“. Yes, I view this as temporary and there will be pent up demand, but as I think through what happens over the coming months, it goes something like this:

  1. Markets have tanked, fear is palpable, there have been runs on grocery stores. Consumers are literally quarantined so the only thing they can think about is the pandemic which drives more fear
  2. Congress and Fed act quickly, but this also tells people that things are serious. Congress puts together a bill to give $1,000 to every American; agrees to provide some loans to essential industries
  3. Just like GM – I don’t see why Congress would give a subordinated loan to these industries. In other words, it primes (or comes in front of) existing lenders plus equity holders. It’s hard for me to see how equity holders get out scot-free here, as well as bond holders. Haircuts will be taken.
  4. Even with Congress taking action, if I work in the restaurant, bar, travel, event hosting, leisure, or any service industry remotely attached to that, I’m thankful for $1,000, but I am worried about my job. I pull back spending considerably. As a consumer, thanks for the grand, but I still am not spending much.
  5. This ripples through the economy. First pullbacks on major purchases (vacations clearly cut, but also autos and home buying) and that continues through everything else.
  6. All the while, US count of the virus will likely grow considerably. We likely reach 100,000+ cases as more tests come out. This will cause the market to freak out and people will go from thinking this is a four week thing to a 12 week thing… maybe longer. The market always assumes the bad things will last much longer than they do.
  7. Media headlines will run rampant.
  8. You will also see bankruptcies of small and large businesses. BDCs and middle market private equity that invested (& levered up) companies with major customer risk and exposure to small business? See ya later.
  9. Elsewhere, cases will begin to decline. Markets will take a deep breath that the measures are working, even if they continue to climb in the US. The market is forward looking so they will see hopes for the US.

So what does that mean for equity prices? I think we have further to fall, unfortunately. Don’t get me wrong – I fundamentally do not believe you can time these things (“Well gee, you sure did waste a lot of text writing about what you think will happen…”) and I have bought many names throughout this bear market. As I noted in my cruise lines post, which was really clickbait for readers to see that long-term intrinsic values of businesses will be fine,  I think this creates a good opportunity to buy high quality businesses.

At the same time, I look at the market and it is just below / slightly above Dec 2018 lows depending on which market you’re looking at. As a quick barometer or sanity check, that doesn’t seem low enough for truly pricing in a destruction to GDP in Q2 this year and people worrying about systemic issues.

Backing it up to a P/E ratio: If we did $164 in EPS for 2019. There’s probably 0% chance we’re up from that number. We can haircut it though and multiple to see where things could shake out this year.  You can argue that because these are depressed earnings and we all likely expect a rebound, that the market should trade at a premium multiple. However, I rarely see that play out in real life. Panic causes people to over shoot. And again, this is a cheapness indicator, not an intrinsic value indicator because one year of bad earnings does little to impact your DCF.

This essentially tells me that my “back up the truck” moment for S&P500 is somewhere around 2,000 and below and I’ll still be a buyer at around 2,300 because I believe the storm clouds will eventually pass and this shows if we go back to 18x $164 in earnings, that is very solid upside.

Ok – I put my thoughts out there. I open myself to being wrong in the future and this post won’t be deleted. Where do you think we shake out? Why?

Time to buy stocks? Here are data points worth considering. $SPY

The market is clearly in panic. Americans and other global citizens in quarantine will clearly not help most businesses (and therefore it doesn’t help stocks). So should we buy stocks now?

One piece of data I came across this weekend was Open Table’s data on restaurant reservations, found here.  As shown below, the US saw a ~42% decline in reservations Y/Y and globally they are down 40%.

Not to mention, we have many public school closures, work travel has been postponed, cruises are putting up ships, and restaurants and bars are limited to take-out meals only. Heck, I can’t even go to the gym anymore. This will clearly crimp many businesses and could pressure liquidity.

This feels like SARS and 9/11 rolled into one. After 9/11, business confidence was hammered and many consumers were fearful and did not want to travel or go out to eat as much. United’s CEO said that this experience has been worse than 9/11 –

After 9/11, revenue was down 40% for two months and then began a gradual recovery… Our gross bookings in the Pacific are down about 70%, so there are still some bookings occurring even in the Pacific region. In Europe, our gross bookings are now down about 50%. Domestically, we’re currently seeing net bookings down about 70% and gross bookings down about 25%. While those numbers are encouraging compared to international, we’re planning for the public concern about the virus to get worse before it gets better.”

After 9/11, we had a tremendous shock to the system and it took some time to recover. Peak to trough, the S&P declined ~30% but within time, we recovered relatively quickly. Recall at this time, we entered a recession and also had a lot of air coming out of the tech bubble as well.

So on one hand, we have an extreme scenario. Short-term funding for a wide array of industries will need to be provided and I personally think we will need to see the US government step in meaningfully.

On the other hand, let’s look at the positives.

  • Short-term pain, long-term gain. It appears the US is now taking the virus more seriously. While there will be short-term pain from a quasi-quarantine, this will help damped the rapid spread of the virus. This will also prevent a overrun of our hospitals and healthcare system
  • Authorities acting relatively quickly. The fed has now cut rates 2x and initiated bond buying (QE5). Although this won’t cure the virus, it could help calm financial markets which will then allow for liquidity to flow through to businesses who need it now. While not established yet, I bet we will see a cut to banks’ reserve requirements to also help the system
  • Not a financial crisis. While there are financial aspects to this (i.e. liquidity, companies drawing on revolvers) this is not like the 2008 mortgage crisis. Although banks are now cutting GDP estimates for Q2 and Q3 2020, many expect that demand will rebound meaningfully.
  • The US is behind the curve, and that is a good thing. Although the outbreak is hitting US shores later than Europe and China, it also means we can look at their data to when cases tend to peak and level out. The US now is essentially in quarantine and that will help fight the spread. (Note, I thoroughly enjoyed the charts posted in this WaPo article for how social distancing actually does work). I think the market will move up even if cases in the US are rising once we see Italy, South Korea and China under control.
  • The biggest companies in the world are flush with cash. Add up the cash held by Apple, Microsoft, Google, Berkshire Hathaway, and Facebook. These businesses fortunately will not be facing liquidity needs, represent large proportions of the S&P, and have longer time horizons than most investors today.

With many stocks I look at down 50-60%, this could be an opportunity of a lifetime given they are pricing in a long-term pronounced downturn. As discussed previously, a one-year impact to earnings that everyone largely expects will be temporary has little impact on the intrinsic value of businesses.

In sum, do I think stocks can continue to go down? Yes. They have historically over shot in both directions. But we can’t time it. I personally am looking at a collection of businesses that will continue to compound earnings at extremely attractive rates.

In this case, I think the situation will be written about extensively. There will be things we don’t even know about yet that books will be published on. But as you think about the past and uncertainty, realize that those times are actually the best in terms of investing. Buying when everything looks amazing and nothing can go wrong typically turn out to be poor outcomes (e.g. peak of tech bubble, the calm before the 2008 storm). Everyone knows in hindsight to buy when others are fearful. I’d also add the richest people in the US are typically perma-optimists, not perma-bears.