This holds true for professional and individual investors.
For the investment team at Peters MacGregor, our global investment universe is 50 times the size of the Australian market. In building a portfolio of world-class businesses, our starting point is approximately 8,300 stocks – this is roughly the number of public companies listed on major global stock exchanges that meet our market capitalisation threshold of more than $1 billion.
As you can see from Figure 1 below, our investment criteria, idea generation, research and valuation models, allow us to screen the 8,300 opportunity set down to a watch list of approximately 280 companies. We actively manage our watch list and use our value investing framework to determine the portfolio of 20 to 30 exceptional businesses we own at any one time.
Figure 1: Peters MacGregor Investment Process
Source: Peters MacGregor Capital Management
While a company may tick all the boxes to get on a watch list, for a range of reasons not every stock on a watch list will make it into a portfolio.
During our recent podcast, Nathan Bell and I discussed NVR and Amazon. NVR is a portfolio holding and Amazon is one of the 280 companies on our watch list.
US homebuilder NVR
NVR is a US homebuilder with a superior business model that holds next to no debt and was the only US homebuilder that made a profit in 2009. NVR is currently trading at 12x 2020 earnings. This is substantially less than the current market multiple of the S&P for 2020, which is 15x. Additionally, NVR has grown its earnings per share (eps) by 25 per cent per year since 1994 and carries no net-debt. This is a great example of the type of company we want in our portfolio - low downside risk and high upside return.
Looking beyond Amazon’s retail business
Amazon’s arrival in Australia in November 2017 gained a lot of media attention – we are yet to see if the predictions of Amazon killing retail in Australia pan out, but that’s a subject for another time.
As mentioned during our podcast, investors and consumers have a pretty good understanding of Amazon’s retail business. Some people may be less familiar with the third-party sales program and the success Amazon has enjoyed from its marketplace model. This is essentially an advertising platform where used products are listed on its main product page, the cost is incremental (i.e. no real cost) and Amazon takes a cut of the revenue.
If you are considering including Amazon on your watch list, you need to look beyond its retail business.
One of the big revenue generators and growth runways for Amazon is its cloud business. Officially launched in 2006, Amazon Web Services (AWS) provides scalable, pay as you go cloud-based IT services ranging from computing, storage, databases and applications to data processing.
Companies using AWS rent secure IT infrastructure and services from Amazon as opposed to the traditional buy/own IT model. AWS’ clients include start-ups, SMEs and large corporates such as Expedia, Netflix, Unilever, Airbnb and Suncorp Group in Australia.
AWS’ main competitors are Microsoft, Google, IBM and Oracle. A lot of people assume the cloud business is a commodity that will be competed away by Google and Microsoft. However, this may not be the case. Many analysts and commentators are now talking about the significant head start AWS has on its competitors in this space given it has been offering web services for over a decade.
In my view, you should consider factoring in some of AWS’s competitive advantages when determining your valuation of Amazon. For example:
▪ Amazon CEO Jeff Bezos. Jeff thinks and operates differently from traditional CEOs. The AWS business is just one example of this – effectively the team at Amazon developed a solution in 2000 to solve an internal capacity issue and have successfully commercialised it.
▪ The functionality and reliability of the services.
▪ Attractive, cost-effective pay as you go model that resonates with users.
▪ The rate and quality of the new features and services that AWS has been and continues to release. Amazon’s Q4, 2017 earnings announcement released on 1 February 2018 noted, “AWS continues to accelerate its pace of innovation with the release of 497 significant new services and features in the fourth quarter, bringing the total number of launches in 2017 to 1,430.”
Finally, any valuation needs to focus on growth and revenue results. The AWS growth rate is increasing. In 2017 it climbed to 44 per cent and in 2016 it was 42 per cent. Growing a billion-dollar business in the 40 per cent range is quite extraordinary.
Looking at AWS as an example reinforces the benefit of taking the time to do your research and get under the hood of a company when you are working on your valuations and determining which stocks to add (or delete) from your watch list.
Actively managing and monitoring your watch list will enable you to take advantage of opportunities to add value to your portfolio and, importantly, make informed decisions during all market cycles, including the headline grabbing periods of volatility.
Trevor Scott is Senior Investment Analyst at Sydney-based, global fund manager, Peters MacGregor Capital Management. For information or to subscribe to the monthly newsletter please visit https://petersmacgregor.com.
Disclosure: Peters MacGregor Capital Management Limited holds a financial interest in NVR through various mandates where it acts as investment manager. Peters MacGregor Capital Management Limited does not have a financial interest in Amazon Inc.