Why I won’t own Amazon in my Quality Shares Portfolio
Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.
Amazon is a remarkable company. And there is no doubt it has been a phenomenal success story. Since it listed in 1997, the shares have returned over 85,000% versus 600% for the US stock market.
If I had to guess, I’d say Amazon will continue to thrive over the next decade.
However, I have no intention of buying it for my Quality Shares Portfolio.
Let me explain why.
I like businesses that are relatively simple to understand.
As I say in my Investment Philosophy: “Simple always beats complex in my book, and boring usually beats exciting. I need to understand the accounting and the business model before I invest.”
The first line of my investment checklist is:
“Do I understand the business model? Is it well within my circle of competence?”
Amazon is a complex company. It tends to keep its investments and new projects under wraps for years – there are probably many in the works right now that investors know nothing about.
I’m not criticising that. Many surprises the company has delivered – like the cloud and advertising businesses – have created enormous value. But it does make it difficult to assess Amazon’s prospects.
So, for me, Amazon sits in the “Too hard” pile.
All things to all people
Amazon is trying to be all things to all people. It’s the one place where you can get anything from batteries to dog food and finger covers for cheesy food.
I can speak to my Amazon Echo and watch Prime Video. And business owners can both advertise on Amazon and run their IT on Amazon Web Services.
These are massive, highly competitive markets. And Amazon has executed brilliantly.
But spinning this number of plates can’t be easy. Amazon must continue to operate exceptionally well to remain successful. And that creates a degree of vulnerability.
Compare this to Microsoft.
Historically, Microsoft has not been the most innovative company. And at times its strategy and execution have been heavily criticised. Yet, it has stood the test of time, and is arguably more relevant today than ever.
Current CEO Satya Nadella who took over in 2014 can take a lot of credit for that. However, I believe Microsoft’s dominant market positions, powerful customer relationships and the fact it sells mostly to businesses bought the company time to adapt.
By contrast, Amazon’s competitive, consumer-facing businesses mean it has to stay on top of its game, or risk losing relevance.
A victim of its own success?
Rapid growth in a short time can be challenging for any business to manage. Amazon’s explosive growth during the pandemic is no exception.
In the last three years, Amazon has invested billions into new warehouses to try and keep up with demand. When the economy opened back up and its customers slowed down on online purchases, it found itself with too much spare capacity.
Years of growth also mean the company now has around 1.5 million employees. That’s a lot of people to keep happy, and it’s no surprise it has started to see more strike action.
Growth and success also attract scrutiny. Nowadays, the company attracts enormous attention from the press, regulators and stakeholders. When your every move is put under the microscope, it makes it hard to run your business.
All these issues stem from growth and past success. Which is why I prefer companies that are growing steadily, rather than explosively, and don’t have a constant spotlight on them.
Cash is king
I tend to steer clear of capital-intensive businesses that generate little, if any, free cash flow (the cash left over after things like capital expenditures, taxes and interest payments).
Amazon falls into this category for me. Over the last five years it has spent almost $200 billion on property and equipment. In fact, in 2021 and 2022 Amazon spent more cash than it generated.
Amazon's cash generation & capital expenditures ($bn)
These investments may pay off handsomely. Or they might not (remember the Amazon Fire Phone?) Arguably, many are born out of necessity to keep customers happy, rather than the belief they will make great returns.
And of course, nobody knows for how much longer Amazon will manage to keep the taxman’s demands at bay.
I’d rather invest in capital-light companies that generate significant free cash flow. If they make investments, I need to be confident they can generate attractive returns. Diploma, the niche industrial in my Quality Shares Portfolio, is a fine example, in my opinion. It does a great job of both generating cash and investing it wisely in bolt-on acquisitions.
Another key reason I’ve never owned Amazon shares is that I’ve never suffered from Fear Of Missing Out (FOMO).
I’m more concerned with how much I can lose than how much I might make.
I like to think this helps keep me out of trouble. But sometimes it means I miss opportunities. And Amazon might be one of them.
Do I beat myself up over that? No.
Lest we forget, Amazon is the exception, not the rule. To start by selling books online, expand into selling virtually everything to anyone, then successfully branch out into unrelated areas like cloud computing, is an exceptional feat.
For every Amazon there are thousands of companies that tried similar things and failed. My investment philosophy is designed to try and avoid those failures. I might miss Amazon, but I miss a dozen failures too.
Conviction is key
I’m not by any means negative on Amazon’s prospects – and I certainly wouldn’t bet against it. If I were running a 50 or 100 stock portfolio, I might be tempted to have a couple of percent in Amazon.
But not in a higher-risk, concentrated portfolio like mine. The fact is, there are 15-20 businesses I have greater conviction in than Amazon.
See five-year performance of Amazon and S&P 500
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