The Next Biggest Company in the World?
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon (NASDAQ: AMZN) has always fascinated me as an investment. I love Amazon as a consumer. It’s not unusual for me to place multiple orders in a week. I’m an Amazon Prime member. I own a Kindle. I am subscribed to Audible.com. LOVE IT. It seems to be the perfect company. Recently, Forbes has even published this article about Amazon becoming the biggest tech company in the world.
Despite my love for the company, I’ve believed for at least a year that the stock was simply too expensive. I can admit that I didn’t look far beyond its ballooning price-to-earnings ratio when forming this opinion. But the stock just keeps growing, and since I think so highly of the company as a consumer I decided to take a step back to quantify, even at a crude level, what kind of growth might be left.
Predicting Amazon’s Future
It’s obvious that predicting the future is tough – just ask Morgan Housel and pundittracker.com. Amazon is especially challenging because I think there’s a real chance that CEO Jeff Bezos can see into the future. Alright, he almost certainly can’t, but not many people thought that an online book retailer would become the dominant force in cloud computing before cloud computing was even a well-known market. I think we can safely label Amazon as an ‘extremely dynamic’ corporation.
In 10 years Amazon may be the leader in flying cars or extra-terrestrial precious metal extraction. So rather than try to predict what Amazon will do as a company, I decided to work from the other direction. What will the world’s biggest company look like in 10-20 years? And how much would Amazon need to grow in order to become the world’s biggest company in this timeframe? Please keep in mind that this is purely an exercise to see how plausible the scenario is, and what kind of returns investors might expect if it actually happened.
Estimating the #1 Market Cap
I started with this New York Times graph of the largest market cap companies going back to 1925. I also mined the Thomson One database for largest year-end market cap companies, which went back to 1980, and converted everything into present day dollars to account for inflation. (The NYT graph already did that conversion for me.) You could write several dissertations on why companies continue to get bigger in real terms – global population is growing, consumption is growing, and various technologies allow individual companies to efficiently provide products and services to an ever-growing customer base. But for our purposes it’s enough to roughly quantify the top market cap 10-20 years from now by extrapolating these data sets.
Amazon has done a great job not diluting its shares, so I assumed that they will have roughly 450 million shares outstanding going forward. Luckily there isn’t a ton of difference between the predictions of each dataset. Here’s the return you would expect, depending on if Amazon became #1 10 or 20 years from now.
So if Amazon becomes the biggest company in the world in 2022, the stock could grow by ~15-18% annually between now and 2022. If it takes them until 2032 to become the largest company in the world, the annual returns would be ~8-10% between now and 2032.
Those may sound like respectable, or even outstanding, returns, but most every Fool likes to believe that long-term growth is fueled by business fundamentals. What kind of top- and bottom-line growth would Amazon need to achieve to become this prototypical largest company in the world? I’m glad you asked…
Growth Rates and Margins
I perused the annual reports of the world’s largest company for the last 33 years to grab revenue and net income data. Unfortunately some of these are easier to find than others, so ultimately I got the data for AT&T (’80-83), GE (’94-97, ’00-01, ’03-05), Wal-Mart (’98), Microsoft (’99, ’02), Exxon (’06-11), and Apple (’12). I wasn’t able to find those from ’84-93, but I think the 23 years of data that I did collect is representative of most ranges of markets, from extremely cheap to irrationally exuberant.
This obviously is a little dicey because P/E (Price-to-Earnings) and P/S (Price-to-Sales) ratios can vary significantly by industry, among other factors. Let’s look at the P/S ratio first because, frankly, that is easier when analyzing Amazon. I used the average market cap model and determined the required annual revenue growth that Amazon would need to achieve for the maximum, minimum, and median P/S ratios of these companies.
The 30.2 P/S ratio from ’99 is clearly an ‘internet bubble’ phenomenon, and also a product of Microsoft '99 having the highest margins of any #1 company I collected data on since ‘80. More relevant is the entirely plausible top-line growth rates that Amazon would need to achieve to be a more typical #1 market cap stock with a P/S ratio of 1.7, or even the most extreme P/S ratio of 0.8. Currently analysts are predicting annual revenue growth of 32.6% for Amazon over the next 5 years, and its P/S ratio sits at 2.1.
I mentioned that Microsoft ’99 had the highest net margin (39%) of any #1 company since ’80. You probably won’t be surprised to hear that Wal-Mart had the lowest in this group at just under 3% in ’98. The median was 10%, which happens to be Exxon in ’07. Over two-thirds of the companies I looked at for this project had net margins between 8% and 12%. Even within this group their P/E ratios ranged from 8 to 38. Expected growth rates, macro-economic conditions, and a wide variety of other factors make this completely unpredictable. Amazon’s margins are often the crux of the bull versus bear case for its stock. Bulls say that it is ‘building its moat’, and margins will expand, especially as it adds more sales of electronic media. Bears say that Amazon is the leader in a cut-throat retail industry that requires razor-thin margins, and always seems to reinvest capital to enter new markets.
If I told you I could predict Amazon’s margins 10-20 years from now, you should be extremely skeptical. If I told you I could predict their growth rate, along with some of the particulars of the global economy, you should laugh.
Foolish Bottom Line
As Amazon grows it will be subject to the same “law of large numbers” discussions that Apple has faced in the last year, because growing becomes more difficult as a company becomes larger. But the top-line growth required to become the biggest company in the world is well within reason, and investor returns will still be quite substantial over the next decade or longer, if they succeed. So I’m ending my AMZN underperform CAPS call, and adding it back to my watchlist.
CommonScents has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!