As Amazon celebrates the 20th anniversary of its floatation with a share price of $1,000, investors must not forget that for every tech start-up success story, hundreds of other such businesses will have failed in the process. May was a big month for Amazon. Not only did it celebrate the 20th anniversary of its stock market floatation, but its share price edged past the $1,000 (£776) mark for the first time – not bad going for an internet book-seller that began trading at just under $2 a share. This means that for 49,000%-plus return anyone who bought $10,000 of shares on 15 May 1997 and then hung on for two decades would now have a holding worth close to $5m.
Finding and investing in a great stock may be hard, but holding on to it is harder, and investors who have consciously put up with the extreme volatility of Amazon’s share price for all of the last 20 years must be few and far between. Statistics reveal that Amazon has seen a 10%-plus peak-to-trough decline in every calendar year since it floated. That ‘drawdown’, as it is known, was above 20% in 16 of those 20 years – including declines of 73% in 2001 and 83% the year before. In all, between December 1999 and October 2001, the shares dropped 95%.
Let’s unpack some factors that make Amazon an investment exception:
Amazon's business model has changed considerably
Amazon’s business model has evolved substantially over the past 20 years. It may still sell books – along with pretty much anything else you might want to buy – but its most profitable area of business, cloud-based services, had not even been conceived of when Amazon floated.
This makes Amazon doubly unusual. Not only has it set itself apart from the great majority of technology start-ups by going on to be hugely successful in the first place, it has done so after changing its business model. This is in stark contrast to, say, Facebook and Google, both of which have relied through their history on their commanding market shares of their respective internet segments to drive advertising revenues.
For every successful tech company out there, there are many that fail.
As exciting as the progress of their share price might be, investors need to understand that for every Amazon, Facebook, Google or Netflix, there are many, many other businesses that fail. Simply put, markets very rarely wait two decades for a company to justify valuations that can often be extremely high.
Along with the uncertain nature of the sector, such valuations – traditionally described as ‘eye-watering’ – are a major reason many investors prefer to steer clear of tech companies. Most value investors will not buy into any stock in the hope its underlying growth in earnings will eventually justify its current valuation – not least because growth is speculative in nature, hard to predict and provides no margin of safety.
Having a margin of safety is key
Having a suitable margin of safety is a key pillar of any deep value investing strategy and is very important to our own process. Still, that does not mean value investors will always shy away from the technology sector.
There will always be tech businesses at the opposite end of the spectrum from the Amazons and not all will deserve to be unwanted. Any company can lose its way or go through a rough patch but, providing investors have the expectation it will eventually recover its profits to levels seen in the past, they will be prepared to invest.
“There are many matured tech businesses around, who are out of favour with the wider market but through their business models, show that their market valuations will improve over the longer term,” says Rodriguez.