Warren Buffett revealed May 3 that Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) had invested in Amazon (NASDAQ:AMZN) for the first time in the holding company’s history. On May 15, we found out that its initial bet on Amazon stock was $860 million or less than a half a percent of Berkshire’s $199 billion equity portfolio.
Since the announcement in early May, Amazon stock has retreated in price, delaying hitting $2,000 for only the second time in its history with the first being last August.
So, while the media seem obsessed by Berkshire’s ownership of Amazon stock (Google search the term “Warren Buffett Amazon stock,” and you’ll get 812 results) you could hardly call a weighting of 0.5% a significant commitment on Buffett’s part. By comparison, the Canada Pension Plan Investment Board has an Amazon weighting of 1.1% on a $51.8 billion equity portfolio.
The fact that Buffet is a reformed value investor has investors speculating about where Amazon stock is headed next.
As I said previously, Amazon hit $2,000 on August 30. Then, after hitting its 52-week high of $2,050.50 on September 4, it ended up retreating to below $1,400 prior to Christmas before doing the 2019 climb back to $2,000.
Is $3,000 in the cards or will AMZN face another 30% correction in the second half of 2019 and into 2020? I’ll make a case for both scenarios.
It’s Going to Continue Its Trek to $3,000
Let’s consider Amazon’s free cash flow for the past five years.
It will tell us a great deal about the company’s success trajectory and overall financial health. Keep in mind that free cash flow, especially when we’re talking about a serious growth company like Amazon, can be a bit lumpy as investments are made to grow segments of its business.
Year Free Cash Flow YOY Growth 2018 $17.30B 167.0% 2017 $6.48B -33.3% 2016 $9.71B 32.5% 2015 $7.33B 275.9% 2014 $1.95B
As I said, you’re not going to be able to avoid the lumpy factor. Long-term, however, the trend is unmistakable. Over the past four years, has grown its free cash flow at an annualized annual rate of 72.6%.
So, when Buffett talks about value being the price you’re willing to pay today to get more back later, he’s talking about Amazon. A simple look at its free cash flow grow suggests that it’s not as simple as saying AMZN is overpriced because it trades at 3,9 times sales or 53 times free cash flow.
Why is that?
That’s because free cash flow is king. If you grow that by 73% annually and you’ll find new ways to keep improving it.
A Recession Could Put Amazon Stock in Full Retreat
Amazon’s business is going great guns right now, but what happens if a global recession takes hold?
I know the odds aren’t good at the moment, but investment professionals are increasingly worried that we’re on a slippery slope; once we get on it, it will be tough to stop it in its tracks given interest rates are still reasonably low.
“The risk of an economic downturn has increased substantially,” Morgan Stanley chief equity strategist Mike Wilson stated May 13 in a note to clients. “While last week’s correction helped move the risk-reward closer to balanced, we think there is likely more downside than upside based on our high conviction view that earnings expectations remain too high by 5-10 per cent.”
The reality is that if a 25% tariff is slapped on the remaining $325 billion in Chinese imports that don’t have already have the tax applied to them, the hit to the economy is more than enough to send us into a recession.
Every day that goes by that President Trump and his trade delegation don’t have a signed deal with the Chinese, the likelihood of a recession increases and the probability of Amazon’s share price getting anywhere near $3,000 goes right out the window.
The Reality Is Likely Somewhere in Between
I believe that most things we fear in life don’t come to fruition. That is to say that life usually happens in the boring middle.
Yes, there could be a recession, but even if there is one, it won’t last very long. It’s also possible that Amazon’s AWS business will continue to print money because it’s pretty hard to take away the servers once you’ve got a need for them.
So, where to from here? If I knew that, I’d have already bought some Amazon stock.
What I do know is that Warren Buffett’s a patient man. As long as the fundamentals (free cash flow being a primary one) remain healthy, $3,000 will happen. It’s only a matter of time.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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