3 Reasons Why I’m Adding This E-Commerce Darling to my Portfolio

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It happened again today, I came home from work and there was another one of those smiling brown boxes sitting by the front door.  Inside were products I bought at fantastic prices that were shipped to me at no extra cost.  The company behind the box was none other than Amazon (NASDAQ: AMZN).

I’ve long been a customer of the e-commerce darling but have never been comfortable enough to invest my hard earned capital in the company.  I’ve always felt that this is another one of my great misses and while their products always seem to be selling for a great value, their shares just never seem to return the favor.  My pause still hasn’t stopped shares from rising fourteen thousand percent since their IPO. 

Addressable Market

However, the more I delve into the business and potential of Amazon, the more I walk away impressed.  Currently less than 5% of all retail sales are made online in the US, a number that’s steadily grown over the years.  That amounts to about $200 billion dollars of the $4 trillion we spend each year.  Amazon’s sales are roughly $50 billion annually; with a good chunk of those sales coming outside of the US meaning they are just a fraction of the total retail spend. 

As far as online retailers go, they tower over eBay (NASDAQ: EBAY) in revenue but are well behind brick and mortar retailers like Wal-Mart (NYSE: WMT) or Costco (NASDAQ: COST).  Take a look at this table comparing their key metrics:

<table> <tbody> <tr> <td> </td> <td>Revenue</td> <td>Price to Cash Flow</td> <td>Sales - 5 Yr Growth Rate</td> <td>Gross Margin - 5 Yr Avg</td> <td>EBITD Margin - 5 Yr Avg</td> <td>Inventory Turnover</td> </tr> <tr> <td>Amazon</td> <td>$48.07 Bil</td> <td>58.8</td> <td>31.29%</td> <td>26.20%</td> <td>5.31%</td> <td>10.5</td> </tr> <tr> <td>Costco</td> <td>$88.92 Bil</td> <td>17.6</td> <td>7.49%</td> <td>13.50%</td> <td>3.64%</td> <td>12.3</td> </tr> <tr> <td>eBay</td> <td>$11.65 Bil</td> <td>12.9</td> <td>10.44%</td> <td>75.80%</td> <td>32.23%</td> <td>N/A</td> </tr> <tr> <td>Wal-Mart</td> <td>$446.95 Bil</td> <td>9.8</td> <td>4.18%</td> <td>26.40%</td> <td>6.80%</td> <td>8.5</td> </tr> </tbody> </table>

Think about a future where Amazon begins to rival Wal-Mart in sales but has margins closer to eBay as more third party retailers sell their goods through their platform and they begin selling their Prime memberships to more customers than Costco could ever imagine.  While that might be wishful thinking, the e-tailer has come a long way in the past decade and there is no reason it won’t continue to innovate.  I mean who ever thought an online bookseller would develop the tech gadget that’ll make those paperbacks obsolete?

The Kindle

Speaking of that tech device, remember that smiling brown box I mentioned in the opening, well the next one that’s delivered will have the all new Kindle Paperwhite that I recently pre-ordered.  I’ve always been an avid reader, especially spending lazy summer days reading by my parent’s pool.  These days I do most of my reading on long trips, lugging around a couple of bulky books that I never finished from the last trip.  With less than a month away from my next vacation I decided it was finally time to pack lighter and I bought myself a Kindle. 

I’m not the only one that’s put the books back on the shelf.  It’s not just the e-reader, but the Kindle Fire tablets are priced to make a certain product by a fruity competitor look like a luxury product.  There is a philosophical difference between the two, a philosophy that was recently conveyed by CEO Jeff Bezos when he said, “we want to make money when people use our devices, not when they buy our devices.”  This is the blade and razor model in all its glory, but one Amazon is planning to exploit. 

Prime Time

Speaking of exploit, Amazon has 180 million active customer accounts yet just a hand full of those have upgraded to their Prime membership.  Amazon doesn’t release those numbers, but it’s estimated that they have less than five million Prime customers.  The service provides free two-day shipping with no minimum order size, unlimited instant streaming of thousands of movies and videos and a free Kindle book to borrow each month from their lending library. 

With retail being a volume business, anything they can do to increase the volume and frequency their customers transact with them the better.  Adding in the instant video component is a brilliant long term move for the service.  It pits them against Netflix (NASDAQ: NFLX) $7.99 a month service and undercuts that price by less than twenty bucks a year plus all the other Prime benefits. As Netflix continues to alienate customers by charging more and offering less, Amazon’s taking the other side of that trade by offering more and charging less.  Who do you think will win that battle?

The No Mess Investment

I’ve chosen my winner for the paper trading portfolio that I run called the “No Drip, No Mess” portfolio.  The strategy is a simple one, stock up on dividend and options income and reinvest that into growth stocks.  I’m taking a bit of the income I’ve racked up and putting it into Amazon.  Specifically, I’m starting off with just a half a percent allocation which amounts to just two shares.  That might sound small but hear me out.

I believe that one of the biggest mistakes investors make is over allocating to a stock or a sector.  To combat that I’m just investing the income I generate from the portfolio into more risky stocks.  So far the portfolio’s generated 3.25% worth of income and I’m taking a portion of that and putting it into Amazon.  Over time I plan to invest more capital, especially if there is an unjustified sell off, but I had to start somewhere.

With Amazon the biggest risk I see in the near term is price volatility, I’m buying a great company but it’s also not too far from their all-time high and at a nosebleed valuation.  That’s why I’m investing cash that the portfolio generated and at a smaller allocation.  Over the long term I’m confident that Amazon’s business will significantly outperform the return I could have gotten by reinvesting this income elsewhere. 

Dig Deeper

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latimerburned has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Costco Wholesale, and Netflix. Motley Fool newsletter services recommend Amazon.com, Costco Wholesale, eBay, and Netflix. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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