Market Cap; Part 1 (A look at Amazon)

This post simply consists of commentary. I am not a market adviser. NOTHING IN THIS POST IS INTENDED AS INVESTMENT ADVICE.

The first number I was taught about when I started learning a little bit about investing was P/E. A lot of the most insightful commentaries I read about the market focus primarily on cash flows. Most of the seminars I see catering to regular investors really like dividends. Some of the hot metrics right now that seem to be getting a lot of attention are insider ownership, insider buying, and insider selling. Something that professional traders like to talk about is days to cover, but one number I never really hear anybody talk about is market cap.

This is a crying shame.

Market cap is simple to understand and even easier to overlook. (It's just the total value  Some investors use market cap to sort portfolios into small cap, mid cap, and large cap stock, but other than that, people pretty much ignore it as a source of information about a stock, even though it's an extremely useful indicator.

Consider the following four companies and their market caps.

Amazon (AMZN) has a market cap of $174.2 B.

Facebook (FB) has a market cap of $236.3 B.

Microsoft (MSFT) has a market cap of $351.6 B.

Walmart (WMT) has a market cap of $268.5 B.

Considering any of these numbers in isolation is difficult. Without really digging into the business and looking at where it can expect to earn money in the future, I don't know what any of these companies should be worth. On the other hand, it should be really easy to compare relative valuations.

Walmart and Microsoft both pay dividends which complicates the discussion a little bit, but dividends and share buybacks can be thought of more or less as the company permanently returning some of its market cap to its shareholders. (With that amount being equivalent to what it spends.) In theory, if stocks were priced perfectly, this is the only relative change that should exist between prices of stocks. If people had perfect foreknowledge of what the market would do in the future, they should be able to price that expectation into the stock so that the every stock across the whole market had exactly equivalent returns.

Once you add back in the amount that these companies pay out in dividends and stock buybacks (treating them as though they had been reinvested in the market as a whole -- after taxes -- which, in theory, in a market with perfect knowledge would be exactly the same as the returns of any of these individual companies), the expected relative valuations of these companies 100 years form now, should be exactly the same as their relative valuations today. Amazon is worth 68% of what Walmart is worth. This should mean that, after adjusting for dividends and buybacks over the next 100 years, the market expects Amazon to be worth 64.9% as much as Walmart a century from now; and again a century from then, and again a century from then, on ad infinitum. (Every individual company is probably going to zero eventually, but most will produce spin-offs -- which may recursively continue to produce spin-offs of spin-offs forever -- before they go defunct and practically every company with more than a $100 billion valuation will issue either dividends or buybacks at some point in its future.)

So right now, the market expects the total future value of Amazon to be appoximately:

73.7% of the future total value of Facebook,

64.9% of the future total value Walmart, and

49.5% of the future total value of Microsoft.

This observation transforms investing into a much simpler question than the question of valuing companies. You can instead focus on valuing companies relative to each other. Should Facebook be worth more than Amazon? Should Microsoft be worth twice as much as Amazon?

If you're studying what a company does, I think these kinds of questions are much easier to answer than the question of what a company should be worth in the abstract.

I personally expect Amazon to eventually become the most valuable of the four companies I've discussed. I'll explain why in a future post that focuses on Amazon. Actually, I think Amazon will eventually become more valuable than the three other companies I've listed combined, because I think Amazon beats Facebook at advertising, beats Microsoft in computing services, and beats Walmart in retail. (And beats UPS in logistics and generally wins at several other industries, but Amazon already has a higher market cap than UPS, so that's less relevant to this discussion.) I might devote a post to each of these topics separately.

tldr; Facebook is worth more than Amazon! Do you expect Facebook to provide shareholders more values over time than Amazon? Well, the market does.