11/9/2015
[The Economist]
[Case Study Competition 2015]
Taylor Ternullo, Olawale Olaleye, Junaid Ahmed
Table of Contents
Amazon vs. Wal-mart: .......................................................................................................................................... 3
2015 Retail Trends: ................................................................................................................................................ 4
Future Growth: ........................................................................................................................................................ 5
Analyst Recommendations: ................................................................................................................................. 7
Mispricing: ............................................................................................................................................................. 11
Opportunities for Wal-Mart: ............................................................................................................................. 11
Ubiquity vs. Profitability: .................................................................................................................................. 13
Profitability? .......................................................................................................................................................... 15
Investment Structure: .......................................................................................................................................... 16
References .............................................................................................................................................................. 17
1
The stock market is a very important financial instrument. They represent a claim or ownership
of a company’s assets and earnings. Acquiring a stock actually means taking ownership of some
parts of the company. People invest in stock of companies they perceive to be ‘good’ or ‘healthy’
for a number of reasons; to receive an income from them in the form of dividends, foreseeing a
growth in their value and selling them at a profit, or simply a balance of both.
There are so many factors that determine the stock prices of any company, and why they move
the way they do. At the most basic levels, forces of demand and supply fix the prices, and so
when demand is high (people), prices go up and when more people are selling, it generally drops.
The key to protecting your investments in the stock market are by understanding these factors,
being able to interpret them properly, and knowing where to put your money.
A few things to consider when making investments in stocks include; industry/ sector, size and
potential of company, important statistics like the growth rate and price/ earnings ratios, and the
risks (beta) involved in making the investments. In recent years, finance, healthcare and
technology have been the fastest growing sectors while consumer staples and utilities have been
quite stable with moderate growth. Considering size, larger companies usually have large
capitalization (company worth) and are usually pretty stable with lower growth potential relative
to small-cap companies. Over the long run, small cap stock have tended to rise at a faster pace.
With respect to the growth rate, stocks with moderately above average growth rates and a
reasonable valuation are usually favorites. High-growth stocks on the other hand, are usually
over-priced and have a hard time meeting over bloated investor expectations.
2
The earnings of a company are a very important focal point for the investor. The earnings are the
main factors that influence investors’ evaluation of a company. The price to earnings ratio (P/E)
compared to projected total return is an effective ratio used to determine value. Ideally a
company’s stock is a good buy when the P/E is less than double the projected return. With
regards to risks, the general principle is the higher the risk, the higher the returns and so before
investing, it is important to decide the level of risk the investor is willing to take.
Amazon vs. Wal-mart:
The stock that our group chooses to invest in after careful thought an expert opinion is Amazon.
Amazon hit a huge milestone and is now more valuable than the biggest retailer in the world;
Wal-Mart. Amazon was founded in 1994 and has 154,100 employees worldwide. Amazon has a
23.93% growth rate over the past five years in comparison to Wal-Mart with only a 3.07%
growth rate in the same span of time. The company offers 250 million products on their online
website. Regarding an innovative market, Amazon offers 75,000 new products per day as well as
a new book every five minutes. Amazon is used world wide by 185 countries, while Wal-Mart
only has stores in 27 countries. Amazons website is doing extremely well with 244 million active
users buying many of their most popular products including books and electronics. The most
popular products at Wal-Mart are groceries, which is not a growing trend as of now compared to
technology. During the holiday season, Amazon is the most popular website to buy gifts from
averaging 18 toys per second and selling 16 million products on cyber Monday. Many buyers
placed an order on Amazon’s website right through their phone, which makes the hassle of
buying gifts a lot less extreme with a user friendly website. Marketing is extremely important
when trying to attract new buyers and Amazon takes this very seriously spending 4.3 billion on
advertising alone in 2014 (Peterson, 2015).
3
Amazon is a smart choice for our investment team because the company is doing everything they
can to better their business. The company’s priority is to make their customers happy and they
will trade off short-term profits for the chance to earn long-term customer loyalty. This is
important when taking into consideration our team’s decade long investment plan. Amazon is
considered to have the best corporate strategy measuring up to Google, Microsoft, Apple, and
Facebook by always thinking a step ahead of their competitors. Amazon’s stock is priced far
beyond Facebook, Google, and Apple implying that their earnings have a great amount of room
for growth. Amazon has expanded its third-party marketplace, which involved merchants all over
the world setting up their own virtual stores on Amazon.com. Amazon juggles this while selling
their own products and continually impressing their large customer base. Amazon surely has a
bright future ahead of them (Peterson, 2015).
2015 Retail Trends:
The world is changing day by day and it is up to the companies to create an innovative retail
environment if they want to gain a competitive advantage quickly. Something that is very
important to pay attention to are the retail trends occurring over the years. E-commerce is the
leading trend that is quickly expanding like rapid fire. According to the article, “2015 Retail
Trends” retail sales have grown through online channels and shopping online accounts for 8% of
the total retail sales. There are three sectors that e-commerce have not taken over such as cars,
gasoline stations, and groceries. These categories take up take up almost half of the retail sales
making the e-commerce revenue about 16%. This rate is growing at a rate of 15% beyond
traditional retail. Wal-Mart makes a total of 56% profit off of their groceries and is making a
huge effort to compete with Amazon through e-commerce. This will be difficult considering
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their main profits come from groceries. As more people move to shopping online, this directly
relates to a simplified way of shopping. Buyers can now save money shopping online by
comparing prices and having these items shipped right to their door. Amazon being a very
innovative company has every opportunity for growth especially if the retail trends are in their
favor (2015 Retail Trends, 2015).
Future Growth:
Wal-Mart and Amazon are very different and similar in so many ways. They are hard to compare
because Wal-Mart is a multinational retail corporation, whereas Amazon is an American
electronic commerce company. They both sell retail products through different sales strategies.
Amazon is also a cloud computing company and is the largest Internet based retailer in the U.S.
Amazon starting as an online book store has grown dramatically and continues to grow as time
goes on. Wal-Mart’s overall sales are much higher than that of Amazon’s, but e-commerce is
changing the statistics. Wal-Marts online sales in 2014 were $12.2 billion compared to
Amazon’s being $89 billion. Amazon is making an impact and is being noticed world wide as a
major success. Its online business is growing rapidly and investors are recognizing the
importance of online commerce for retailers today. As shown in the graph below, Wal-Mart
quarter by quarter seems to be declining when it comes to expansion, compared to Amazon’s
growth averaging to 27% in 2014 (D'Onfro, 2015).
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(D'Onfro, 2015)
There are new conveniences for customers such as same day delivery and automated ordering.
Online shopping has gained a larger profit than brick-and-motor by e-commerce’s share rising
from .6% in 1999 to 7% in the first quarter of 2015. Quarterly, this average increases 3.7%
compared to 1.1% for total sales. Wal-Mart is trying its best directly compete with Amazon, but
the company does not stand a chance against their highly innovative website. Wal-Mart stated
that they would spend up to $1.5 billion on its ecommerce business this year and launched a
shoppers club, similar to Amazon Prime, charging its shoppers a yearly fee in order to get free
shipping. The company has also stated that they will make their website more user friendly and
offer a wider selection of products. Wal-Mart.com only offered 1.1% as many products as
Amazon in April. In addition, Wal-Mart wants the users to create accounts in order to gather data
about recommendations of products and offers same day grocery delivery just like Amazon
Fresh. Wal-Mart has a chance of measuring up to Amazon’s ecommerce website, but will never
beat out Amazons unique retail market. Wal-Mart’s core customers are not known to be tech
savvy shoppers, therefore their online revenue will suffer. Although Wal-Mart has been making
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large investments into ecommerce, their online revenue is only 2.5% of the company’s total sales
proving they still have a long way to go. Amazon is now a leading clothing retailer with analysts
statistics estimating that the company can one day outdo Macy’s as a leading clothing business.
Amazon also has premium baby products with plans to extend its private-label to food and
household essentials. By the time it takes Wal-Mart to catch up to Amazons success, the
company will already be expanding and testing their future delivery drones (D'Onfro, 2015)
Analyst Recommendations:
Considering the ratios, the Price to Earning (P/E) ratio for Amazon is 891.60, which are
approximately 3 times more, than the industry i.e. 274.70. This could mean one of the following,
either the company is mispriced or it has a high growth rate. Looking at the growth rate, Amazon
has a 5-year growth rate of 23.93%, which is higher than the industry i.e. 18.76. Amazon has a
Beta of 0.90, which is indicative of higher risk investment. But theoretically, we know that a
higher risk of an investment the higher the potential of returns (ROI) on such investments.
Looking at the gross margin ratio, which is also the profitability ratio, Amazon has 38.30
compared to the industry, which shows that Amazon is relatively profitable.
Also looking at the Price-to-Sale and Price-to-Book value, Amazon appears to be doing better
then the industry benchmark. These are all very positive quantitative aspects of Amazon.
Wal-Mart on the other hand, has the Price to Earning (P/E) ratio of 12.10, which is lower than
the market benchmark i.e. 19.80. Also the growth rate of Wal-Mart is 3.07, which is 3 times less
then the industry i.e. 10.37. The gross margin ratio for Wal-Mart is 26.80, which is barely higher
than the industry i.e. 25.70.
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Company
Average Analyst
MEAN
Recommendation
Amazon
BUY
BUY
Wal-Mart
BUY
HOLD
The average price of Wal-Mart’s stock in 2005 was approximately $45. Currently the average
price for the stock of Wal-Mart is about $55 representing an 18% increase in the last 10 years.
Whereas, Amazon had an average stock price of $43 in 2005 and now it is $629, which
represents 1,350%, increase in price.
Many investors rely on the recommendations of capital market analysts to choose their portfolios
because of analysts’ greater market expertise and specific knowledge about the companies they
follow. Analysts are arguably the eyes and ears of the market.
Analysts provide an important source of information in today’s market. They promote the
efficiency of the markets by referring facts and offer valuable insights on companies and industry
trends. The mere mention of a company by a popular analyst can temporarily cause its stock to
rise or fall.
The whole point of relying on analysts’ recommendations is that they are specialists with deeper
knowledge of the market and the companies they follow, allowing them to reach more accurate
forecasts of future returns than an ordinary investor could do.
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It is quite evident that the analysts are in favor of Amazon to invest or buy in stocks compared to
Wal-Mart. The historical data depicts an increase in analyst’s interest in amazon. Multiple
factors could be a reason e.g. the boom in technology, which is pushing the market toward the
trend of online shopping instead of in-store shopping. In turn, this makes it a potential company
with respect to future growth in the market.
9
Mean Recommendation Conversion Table
1.00 thru 1.24 = Buy
1.
25 thru 1.74 = Overweight
1.75 thru 2.24 = Hold
2.25 thru 2.74 = Underweight
2.75 thru 3.00 = Sell
The worldwide expansion of the Internet has considerably contributed to the transformation of
trade and in-store transactions. E-commerce statistics confirm the explosive pace at which this
industry has developed as a worldwide B2C e-commerce sales, which amounted to more than 1.2
trillion US dollars in 2013.
10
Mispricing:
Mispricing is a misrepresentation of the true value of a stock and a mispriced stock may mean it
is undervalued or overvalued by the market. Calculating the fair value of the stock currently and
comparing it with the market price is one way to determine if its mispriced.
Fair Value (AMZN) =
For Wal-Mart
456.9* 1.85 (using a 5 year average P/E * annual EPS)
=
$845 per share
=
14.3 * 4.96
=
$70.93
Compared to the current market value, both stock are underpriced with amazon by a larger
margin. Another way to determine is to consider analysts opinions. If most analysts suggest that
you buy a stock this means that it is not mispriced. Considering the analyst’s recommendation,
they believe Amazons stock is a good buy right now. This is suggested because Amazon has a
large potential for future growth and Analysts predict that the stock’s price will continue to
increase.
Opportunities for Wal-Mart:
The changes that Wal-Mart must make to effectively compete in the Internet age consists of data
that we analyzed within their S.W.O.T analysis. The first thing Wal-Mart should do to compete
in the internet age would be etailing. Wal-Mart can promote the concept of egroceries, which
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would benefit the company in terms of getting the insides of the customer buying patterns In
turn, this can be used to target personalized promotions and marketing. Wal-Mart needs to
expand their program for in store pick up of groceries. Right now, Wal-Mart has only 13 stores
in total that actively use this program. On the other hand, Amazon offers all programs they have
everywhere, simply because they operate online. Expanding this program to all stores will be
vital for Wal-Mart to continually increase their profits in groceries. Also, Wal-Mart must find
more innovative ways to sell their groceries because about 59% of their revenue comes from
groceries (Peterson, 2015). Their biggest profit margin comes from their grocery sector;
therefore it is highly important to keep up with the global trends. The trend of healthy eating is a
way Wal-Mart can position their company for success. Also, the company should highly
consider going into online perishables because that stands as an opportunity for infrastructure.
Strengthening their brick-and-motor store channels will result in a positive outcome for their
stores. If Wal-Mart develops a seamless integrated channel shopping experience by making a
presence online and experimenting with the services offered across channels they will have a
chance to measure up to Amazons single channel. Wal-Mart must diversify their products in
their industry in order to appeal to larger target market. This company has many opportunities
such as a retail market growth in emerging markets and private label products (Wal-marts SWOT
analysis, 2015).
According to our research, Wal-Mart should try to directly compete with Amazons online
website because they set the standards for online shopping. With this in mind, Wal-mart should
then expand their market by creating a portal to bring all their vendors to one table. Amazon is a
portal for finding anything on one page. Anything that you find on Wal-mart’s website you can
only find in store. Wal-Mart needs to increase their options online to more than what they offer
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in store. Wal-Marts stock in store is 140,000 SKU’s whereas over the internet it only has
100,000 SKU’s. This limits customers online shopping. Amazon gives more bargaining power to
buyers because they are open to any vender, but Wal-mart offers limited bargaining power to
buyers by only offering in store items. Amazon has created a user friendly website with cheap
offerings of products all in one page. Wal-Mart has to compete directly with Amazon by offering
all of these qualities that do not exist today (Wal-marts SWOT analysis, 2015).
Another very important trend that exists today is social media. On twitter, Wal-Mart has 708.2
thousand followers in comparison to Amazon, which has 2.1 million followers. Amazon spends
$4.3 billion on advertising, whereas Wal-Mart spends 2.4 billion on advertising. Wal-Mart must
make a bigger impression for the Internet age because this type of marketing is vital for
attracting and retaining buyers. The traditional marketing techniques are being used less and less
and marketers are finding that they are spending less money by advertising online. When
analyzing Wal-Marts employee’s satisfaction scores it is evident that they need make employee
happiness a priority because they have an extremely high turn over rate. Creating a positive
working environment for all employees makes a lasting impression of Wal-Mart in all levels of
the business (Wal-marts SWOT analysis, 2015).
Ubiquity vs. Profitability:
Amazon has such a competitive advantage in online shopping that they will be able to go into
any industry and succeed. Amazon has a presence everywhere in the world and Wal-Mart is only
presented where their stores are located. For example, Amazon is also the leading web service
provider and a major play in the game business. Amazon is thinking far beyond their balance
sheet because they want to be successful globally. Amazons goal is “to be everywhere for and
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everything to consumers” (Amazon Grocery, 2015). Stock investors are applauding Amazon and
believe that their company will be apart of our daily lives, just like Apple. It is predicted that
Amazon is going to quadruple its earnings per share by next year.
As long as the company can grow its revenues, it can spend any profit it makes on new lines of
business that create more revenue. Those revenues may also be profitable, and profits can in turn
be immediately spent again on more growth. By eschewing profits, the company can also offer
the lowest prices possible. Some parts of the company are profitable and fuel growth in others
(Edwards, 2015).
(Edwards, 2015)
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Profitability?
Every investor is interested in the profitability of whatever company they are investing in.
However, when it comes to investing in stock, investors consider more than profitability at the
time of investing. The future potential of the investment is always more important than the
current profitability when making a choice between stocks. It is possible for a company to be
profitable today and decrease in a few years to come. Therefore, the future potential is always the
most important in making an investment decision.
Amazon may be losing a large sum of money, but they are generating huge sale volumes and a
growing market share. Revenue is increasing, benefitting profit. Short-term gains are sacrificed
for long-term goals and it seems to be working in the company’s favor. Amazon’s growth is
outpacing overall ecommerce and retail growth, which means it is succeeding at stealing market
share from competitors. Of course there are also ways to hedge some of the losses from their
core retail business through higher margin avenues like their Amazon Web Services (cash cow).
Amazon has razor-thin margins and actually, according to Yahoo Finance, Amazon’s profit
margin is negative (-0.15%, 2009) at the moment. A bottom dollar strategy like this does not
always work, but for a company like Amazon that has built up sufficient resources and the
reputation to support such a strategy, it can. Part of the strategy may be to build up Amazon’s
brand to the point where the trust factor will eventually build in a “premium” factor. In turn,
consumers will be willing to pay a premium price to get a certain item from Amazon versus
other vendors (2015 Top 250, 2015).
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Investment Structure:
We would structure our investment by buying Amazon using the put option to protect the value.
This option gives us the right to sell a stock at a certain price. When we choose the put option we
will have to pay a premium. Amazons stock is priced at $657 as of November 6, 2015, therefore
the strike has to be equal to 600. The higher strike the higher premium. The strike being 600 is
equal to .06 cents per option premium, which is very low. Are plan is to keep buying the option
to protect value over a decade long period. It will cost our team .06 cents for one option,
therefore .06 X 100=$6 for one contract. At any point we have the right to sell for $600 if we
choose to do so. After this expires, we buy put option once again. If stock price goes down the
book value goes up and we keep the put at that point. We could loose money, but in turn make a
lot on the put option. We expect that this stock is going to do well in the long run, but at the same
time we do not know what will happen in the market and to protect this value we will use the put
option. Amazon is able to convince investors that $657 is a good price because ecommerce is
always highly relative to the future. It is clear that investors see a large growth potential with the
stock being at such a high value. Amazons past and strong potential growth work in congruence
with each other creating a bright future for Amazon and their stock. Amazon is the right stock to
invest in and will certainly give our group the highest return.
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References
Amazon Grocery Puts AMZN One Step Closer to Apple-Like Ubiquity. (2015, July 28).
Retrieved November 6, 2015, from http://investorplace.com/2015/07/amazon-amzn
stock-stock/#.VjfQcaLseKJ
D'Onfro, J. (2015, July 25). Wal-Mart is losing the war against Amazon. Retrieved November 6,
2015, from http://www.businessinsider.com/wal-mart-ecommerce-vs-amazon-2015-7
Edwards, J. (2015, January 30). Amazon's profit shows how few people understand the way the
company works. Retrieved November 6, 2015.
Peterson, H. (2015, July 13). The key differences between Wal-Mart and Amazon in one chart.
Retrieved November 6, 2015, from http://www.businessinsider.com/amazon-vs-wal
mart-in-one-chart-2015-7
Wal-marts SWOT analysis 2015. (n.d.). Retrieved November 6, 2015, from
http://www.strategicmanagementinsight.com/products/swot-analyses/walmart-swot
analysis.html
2015 Retail Trends. (n.d.). Retrieved November 6, 2015, from
http://www.strategyand.pwc.com/perspectives/2015-retail-trends
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2015 Top 250 Global Powers of Retailing. (n.d.). Retrieved November 6, 2015, from
https://nrf.com/news/2015-top-250-global-powers-of-retailing
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