Wed, Mar 12, 2014
Every quarter that Apple, like Microsoft before it, announces record profits and their stock price goes down, Apple’s fans (and though that label might seem dismissive, it’s actually apt, as those partisans’ involvement in Apple’s business is almost precisely that of sports fans’ involvement in “their” team) take to their Internet forum of choice to decry this as, at best, cluelessness or, at worst, actionable market manipulation. There’s a rule taught in any Finance 101 class that, if it doesn’t offer those fans any comfort, would at least help them understand what’s happening. The value of a stock is the present value of the company’s expected future profits. A corollary to this rule is that based on some slightly more advanced calculus, the value of a stock only increases if the expected rate of growth of those future profits goes up—not the profits themselves, but their rate of growth. So if, for example, everyone expects a company’s profits to increase at 10% per year, and they do, the price of the stock will already reflect that expectation and it won’t go up as a result of meeting those expectations.
What happens if a company has an unexpectedly good quarter during which profit growth exceeds expectations? It depends. If that unexpected growth heralds as yet unaccounted future growth, then the stock price should go up. If, on the other hand, it’s the result of a one-time event or, worse, will make future acceleration of profit growth even harder to come by (because, say, the company has sold an operating system, office suite, or iDevice to everyone who might be expected to buy one), the stock price should stay the same or go down. In those cases, all the company has accomplished is to move future profit growth into the past, from whence someone buying the stock today can no longer receive any benefit. If a company’s management’s goal is to increase its stock price (and many seem to feel that’s their only job), then it behooves them to cultivate ever-increasing expectations of future profit growth, and that can actually be easier to accomplish if the company hasn’t yet experienced profit growth. Enter Jeff Bezos.
Amazon’s stock price is obviously unrelated to its past or current profits. Bezos, a former market player himself, has taken all of the Amazon earnings that might have been profits and spent them in a way that the market believes will ensure faster and faster profit growth in the future. It’s almost, but not quite, as if Amazon is able to count its earnings twice: first as a demonstration that it can generate revenue, and then as an investment that will generate future revenue. That is, Amazon is able to make a compelling case that significant and steadily increasing profit growth lies in a future that Amazon can realize whenever it chooses. This will work for as long as Amazon can hold off that future and retain its credibility. Once Amazon begins to realize those potential profits, by decreasing expenses, profit will grow quickly and then level off as investment toward future revenue generation tails off. This will lead to a run up in stock price followed by stock price stagnation reminiscent of Microsoft and, more recently, Apple. As much as their investors might like to believe it (assuming they even care), Amazon hasn’t figured out how to defy gravity.
Beyond possible strategies for playing the market, what does this mean in the real world? The benefit of Amazon’s stock price appreciation and, when it decides to take them, profits will go to Bezos, a few people around him, and investors who, by and large, live by the earnings of their wealth. The rest of us, who live by our wages, are the expenses that are tolerated so long as they promise future profit growth, and that will be eliminated when it comes time to see those profits. For the present, so long as it deigns to incur current expenses that promise future profits, Amazon is instead eliminating the expenses, otherwise known as sustaining economic activity, of precursors, competitors, and suppliers at a rate that threatens to dwarf even the impact of Wal-Mart (which I suspect Amazon sees more as a precursor than as a competitor). And yet, aside from Kindles and a few other products, Amazon creates nothing. This vast extinguishing of economic activity in the service of the context-free convenience that Amazon offers suggests the Platonic ideal of a corporation toward which Amazon aspires (but can never achieve): a company that makes nothing but profit and spends nothing. Notice all that is missing from that picture.