Saturday, October 1, 2011

Research: AMZN Great company but overpriced, AGAIN

AMZN - There have been many times that I've wanted to go short or buy puts on AMZN. I've managed to retrain myself because I know that overvalued companies may stay overvalued for a very very long time. And it may continue to become even more overvalued. It's a great company but a terrible stock. It's simply too expensive.

It has a great business model. Most of its accounts receivables are from the Amazon credit card. Aside from that, Amazon generally gets paid up front for purchases. The large accounts payable is because Amazon has some time before paying the sellers. Amazon requires very little to keep the business going, hence the small amount needed for capital expenditures relative to operating cash flow.

One of the great things about Amazon is that it's NOT repurchasing its own overpriced stock, unlike NFLX. It is properly allowing its outstanding shares to increase, saving the shareholders from the destruction of equity via repurchases. Amazon can actually further increase current shareholder value by issuing more stock. Benefits to current shareholders will be at the expense of new shareholders.

Imagine a company that has no operations or expenses. It's just a bank account with 100 dollars. The intrinsic value of such a company is easily calculated as 100. There is currently 1 share of outstanding stock. The company decides to issue 1 more share. Someone (donk) decides to buy the newly issued share at 200. The company receives the 200 dollars and puts it in the bank, which increases to 300. Then, the company pays a dividend of 50 dollars per share.

The first shareholder now has 50 bucks in cash, and 1 share of stock which represents 50% ownership to the remaining 200 dollars. The second shareholder also receives the exact same thing. NOTHING has changed for the first shareholder, except that he now has an additional 50 bucks in cash. The second shareholder just got screwed.

While you may dispute the etiquette of such actions, issuing more overpriced stock and instantly paying a dividend is a sure way to benefit the original shareholders.

2 comments:

  1. Correct me if I'm wrong, but I think that elaborated it means that the first shareholder has essentially 150 dollars for paying 100 dollars, but the second shareholder has 150 dollars for paying 200 dollars.

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    1. That's right. With the intrinsic value at 200 and 2 outstanding shares, each shareholder has a right to half of that bank account. First shareholder has received the 50 dollar divide, and has rights to 100 dollars of that account, which is 150 total. The second shareholder paid 200 dollars, received a 50 dividend, and also has a claim on 100 of the account. His wealth totals 150 as well, even though he paid 200 to buy the share. This is the result of overpaying for a stock.

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