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Real Vision Investment Case Study
The Economist Case Study Competition 2016
Presented By: “Team Precision”
Jorge Gaspar
Chris Gillespie
Allysa Kiedpool
November 9, 2015
Contents
1.
Introduction ............................................................................................................................. 1
2.
Key Figures ............................................................................................................................. 1
2.1.
3.
4.
Stock Valuation ................................................................................................................ 1
2.1.1.
Amazon Expected Value........................................................................................... 2
2.1.2.
Wal-Mart Expected Value ........................................................................................ 3
2.2.
Price/Earnings (P/E) Ratio: .............................................................................................. 4
2.3.
Recent Sales ..................................................................................................................... 4
2.4.
Recent Earnings Per Share ............................................................................................... 6
2.5.
Debt Ratios ....................................................................................................................... 7
Portfolio Structure................................................................................................................... 8
3.1.
Overview of Investment Strategy..................................................................................... 8
3.2.
Wal-Mart Stores Inc. Stock as an Investment .................................................................. 8
3.3.
Amazon.com Inc. as an Investment ................................................................................. 9
3.4.
Recommendation of Investment Strategy ........................................................................ 9
SWOT Analysis ...................................................................................................................... 9
4.1.
Amazon SWOT Analysis ............................................................................................... 10
4.1.1.
Internal Strengths .................................................................................................... 10
4.1.2.
Internal Weaknesses................................................................................................ 10
4.1.3.
External Opportunities ............................................................................................ 11
4.1.4.
External Threats ...................................................................................................... 11
4.2.
Wal-Mart SWOT Analysis ............................................................................................. 12
4.2.1.
Internal Strengths .................................................................................................... 12
4.2.2.
Internal Weaknesses................................................................................................ 12
4.2.3.
External Opportunities ............................................................................................ 13
4.2.4.
External Threats ...................................................................................................... 13
5.
Conclusion ............................................................................................................................ 15
6.
Appendix ............................................................................................................................... 16
i
1. Introduction
As a rule of thumb, ordinary investors are told by professionals to purchase the stocks of
companies that they regularly use. The reason behind this simple strategy is the assumption that
there is some value the investors, and the masses, derive from the companies they regularly use.
Thus, those companies are doing something right. This paper takes that qualitative reasoning
deeper with both Amazon.com Inc. and Wal-Mart Stores Inc. What would be the reasons
someone may invest in either of these two companies? Some quantitative calculations of the
financial situation of both companies will help shed a bit of light on their current situations, but
what about the next ten years? What stock would be a better investment if investors had to hold
on to the stock for the next ten years? Those questions, and more, are answered in the following
sections.
2. Key Figures
There are several key figures that are used to help investors evaluate stocks. The following
section provides an analysis of the stock value and financial health of both Amazon.com Inc. and
Wal-Mart Stores Inc.
2.1.
Stock Valuation
Calculating the intrinsic value of a stock can be easy if the right data is available. For investors,
knowing the true value of stocks versus the market value of stocks, can give a clear picture on
whether or not a stock is under or overvalued. With that information, it's easier to decide if a
specific stock should be invested in, shorted, or avoided altogether? Difficulty with calculating
the intrinsic value enters the picture when specific data is not available for one reason or another.
Alternative methods are available for such situations, as is the case with Amazon.com Inc.
Page | 1
2.1.1. Amazon Expected Value
A basic way to calculate the intrinsic value of a stock is by first using the Capital Asset Pricing
Model (CAPM)1 approach to calculate the expected return of a stock. The basic data needed for
the CAPM calculation are the expected return of the market, the risk free rate, and the beta of the
stock the calculation will be for.
Expected Return = Rf + (Rm-Rf)*b
The next step in working towards calculating the intrinsic value is to use the Constant
Growth Model, also known as the Gordon Model. In order to complete the calculation for the
Gordon Model, the dividend growth rate, the dividend of amount of the next period, and the
expected return of the stock are all needed.
Intrinsic Value =
Where:
D1 = Dividend Amount for the Next Period
k = Expected Return of the Stock
g = Dividend Growth Rate
As mentioned, Amazon.com Inc. stock requires an alternative method to calculate the
true value. The reason for this is because Amazon has never paid out a dividend to shareholders.
As a result, the Gordon Model is rendered useless for Amazon’s stock calculation. An
alternative method is called P/E Multiple2. This method requires the current price to earnings
(P/E) ratio and the forecasted earnings per share (EPS) for the next period. In this case,
Amazon’s current P/E ratio (as of Q3), is 731.27. The forecasted EPS for Q4 is $1.633. The
product of the two delivers a stock price valuation of $1,191.97 per share.
1
Parwar, Anil, Fundamentals of Finance, Pearson 2010
Parwar, Anil, Fundamentals of Finance, Pearson 2010
3
http://www.nasdaq.com/symbol/amzn/analyst-research
2
Page | 2
Intrinsic Value = P/E Ratio * Forecasted EPS
Intrinsic Value = 731.27 * 1.63
The price per share of Amazon.com Inc.’s stock at market closing on Friday November
6th, 2015 was $659.37. This would indicate Amazon.com Inc.’s stock is greatly undervalued in
the marketplace.
2.1.2. Wal-Mart Expected Value
Wal-Mart Stores Inc. stock is a different story, and can be calculated the traditional way,
explained earlier, by using the CAPM and Gordon’s Model. The S&P 500 2014 return is used to
calculate the expected market return of 14.04%4. The 10 year Treasury bond is used as the risk
free rate at 2.33%5. The beta of Wal-Mart Stores Inc. stock is averaged using five sources at
0.614. CAPM expected return on the stock is calculated below.
Expected Return = 2.33 + (14.04 – 2.33)* 0.614
Expected Return = 9.52%
The dividend growth rate for Wal-Mart Stores Inc. stock is calculated using the past five
years of dividends, which calculated an average annual growth rate of 6.07%6. The expected
dividend one year from now is calculated by multiplying the current year’s dividend ($1.96) by 1
+ dividend growth rate, which yields a calculation of $2.08 per share. Using the expected rate of
return for Wal-Mart’s stock, calculated using CAPM, the Gordon’s Model is now used to
calculate the intrinsic value of the stock.
Intrinsic Value =
–
Intrinsic Value = $60.27 per share
4
http://seekingalpha.com/article/2791755-2014-s-and-p-500-return
http://finance.yahoo.com/q?s=^tnx
6
http://stock.walmart.com/investors/default.aspx
5
Page | 3
The price of Wal-Mart Stores Inc. stock at closing on Friday November 6th, 2015 was
$58.78 per share. The stock, according to the CAPM and Gordon’s model is slightly
undervalued, but relatively close to the market valuation.
2.2.
Price/Earnings (P/E) Ratio:
The investor should also evaluate the company’s financial statements. Revenue growth is a good
indicator there is a chance as the revenues grow; the stock price will increase as well. The P/E
Ratio shows how much investors will be willing to pay for every dollar of profits reported. The
P/E ratio is calculated using the formula below7:
P/E Ratio =
Amazon P/E Ratio(as of 30-Sep-2015) =
Wal-Mart P/E Ratio (as of 31-Jul-2015) =
8
9
= 731.27
10
11
= 15.03
Relatively high P/E ratios indicate strong growth for the firm and little risk. Amazon’s
high P/E ratio could be due to the fact that they always reinvest its earnings into the company for
future growth.
2.3.
Recent Sales
Looking at the P/E ratio alone was insufficient in evaluating Amazon and Wal-Mart stock. The
graphs below will show Amazon annual sales from 2010 to 2014 and Wal-Mart’s annual sales
from 20101to 2015. Also included in the graph is the sales growth rate year over year. As per
Figure 1 and Figure 2 below, both Amazon and Wal-Mart have increased sales year over year.
7
Brigham, Eugene F., and Houston, Joel F,. Fundamentals of Finance, South-Western Cengage Learning, 2013
http://www.marketwatch.com/investing/stock/amzn/historical
9
http://www.marketwatch.com/investing/stock/amzn/financials
10
http://www.marketwatch.com/investing/stock/wmt/historical
11
http://www.marketwatch.com/investing/stock/wmt/financials
8
Page | 4
Both companies have increased sales growth since 2011, however, Amazon’s sales growth were
increased in double digit percentages. From 2013 to 2014, Amazon’s sales growth was 19.52%
and Wal-Mart’s sales growth was 1.52%. It is clear that when it comes to earning billions of
dollars, Amazon is the clear winner with a sales growth of 19.52% from 2013 to 2014.
Amazon Sales (In Billions), Fiscal Years (2010-2014)
$100.00
88.99
74.45
$80.00
50.00%
40.00%
61.09
$60.00
$40.00
30.00%
48.08
34.2
20.00%
$20.00
10.00%
$-
0.00%
2010
2011
2012
2013
Sales (In Billions)
2014
Sales Growth
Source: http://www.marketwatch.com/investing/stock/amzn/financials
Figure 1. Amazon Sales
Wal-Mart Sales (In Billions), Fiscal Years (2011-2015)
$500.00
$480.00
$469.16
$460.00
$440.00
$476.29
$485.65
7.00%
6.00%
5.00%
$446.95
4.00%
$421.85
3.00%
$420.00
2.00%
$400.00
1.00%
$380.00
0.00%
2011
2012
2013
Sales (In Billions)
2014
2015
Sales Growth
Source: http://www.marketwatch.com/investing/stock/wmt/financials
Figure 2. Wal-Mart Sales
Page | 5
2.4.
Recent Earnings Per Share
EPS serves as an indicator of a company’s profitability, which makes EPS an important figure
for investors. The EPS is portion of a company’s profit that is allocated to each outstanding
share of common stock12. EPS is also known as “the bottom line”, which refers to all of the
items on the income statement. Figure 3 below shows Amazon and Wal-Mart’s EPS through
fiscal years Q3 2014 through Q3 2015. Analysts initially estimated a loss for Amazon at the end
of Q3. However, Amazon exceeded EPS estimates and reported positive earnings instead of a
loss. Amazon is expected to increase revenue by 20% and recently announced hiring 100,000
temporary seasonal employees13. Wal-Mart’s EPS increased by 4.85% from Q2 to Q3, however,
it is expected to decrease in the current fiscal year and to continue to decrease through 2017.
The drop in earnings is due to Wal-Mart’s plans to invest in people and technology14.
Amazon & Wal-Mart EPS, Q3 2014-Q3 2015
1.8
1.4
1
0.6
0.2
-0.2
Q3 2014
Q4 2014
Q1 2015
Q2 2015
Q3 2015
-0.6
-1
Amazon EPS
Wal-Mart EPS
Source: http://www.marketwatch.com/investing/stock/amzn/financials, http://www.marketwatch.com/investing/stock/wmt/financials
Figure 3. Amazon & Wal-Mart EPS
12
http://www.investopedia.com/terms/e/eps.asp
http://www.thestreet.com/story/13331739/1/amazon-earnings-usually-bring-extreme-volatility-even-as-sharestouch-new-highs.html
14
http://www.forbes.com/sites/walterloeb/2015/10/15/walmarts-disappointing-sales-and-earnings-spell-doom-forthe-industry/
13
Page | 6
2.5.
Debt Ratios
The debt ratio is a financial measure of the company’s leverage. It measures the percentage of
funds that are funded by creditors15. A higher debt ratio indicates that the company has more
leverage and may imply a higher financial risk. Debt ratios over 100% can be a result of a
company having more debt than assets16. The debt ratio is calculated by dividing total debt by
total asset as per the equation below17:
Debt Ratio
=
Amazon Debt Ratio (as of 30-Sep-2015)18 =
Wal-Mart Debt Ratio (as of 31-Jul-2015)19 =
= 62.07%
= 52.28%
Although Amazon has a higher debt ratio than Wal-Mart, debt can be a necessity for a
growing company. Amazon has many plans to expand its brand. Amazon is currently testing
out their first “brick-and-mortar” storefront which opened on November 3, 2015 in Seattle,
Washington20. Amazon recently spearheaded commercial drone testing and received permission
for testing21. Amazon has recently made strong moves into the exclusive and original content
market, by signing on former Top Gear presenters to produce a new car show of 36 episodes for
$250 million on Amazon Prime streaming. Amazon has also recently started to offer offline
access to its videos to its member on Android or iOS, something that no other streaming service
offers. Amazon also acquired Twitch.tv which is the primary streaming platform for e-sports. A
budding industry with estimated 113 million e-sports enthusiasts and 147 million casual viewers,
15
Brigham, Eugene F., and Houston, Joel F,. Fundamentals of Finance, South-Western Cengage Learning, 2013
http://www.investopedia.com/terms/d/debtratio.asp
17
Brigham, Eugene F., and Houston, Joel F,. Fundamentals of Finance, South-Western Cengage Learning, 2013
18
http://www.marketwatch.com/investing/stock/amzn/financials/balance-sheet
19
http://www.marketwatch.com/investing/stock/wmt/financials/balance-sheet
20
http://www.npr.org/sections/thetwo-way/2015/11/03/454250311/amazon-opens-a-real-bookstore-in-seattle
21
http://money.cnn.com/2015/10/26/news/companies/walmart-drone-testing/
16
Page | 7
the e-sports global market is set to bring in more than $250 million in revenue in 201522. In
2014, Twitch claimed a 43 percent share of the $3.8 billion video game content market23.
Wal-Mart announced their plans to spend $2 billion on e-commerce in order to catch up
and compete with Amazon24. Wal-Mart recently asked the Federal Aviation Administration for
permission to test drone delivery as well25. Wal-Mart has made feeble attempts to enter the
streaming market with Vudu as well as attempting to enter the online marketplace. Even if WalMart penetrates the e-commerce market successfully it is miles away from rivaling Amazon in
the lucrative field of online streaming. In addition, although Wal-Mart has a lower debt ratio
than Amazon, these investments plans may cause its debt ratio to increase in the near future.
3. Portfolio Structure
3.1.
Overview of Investment Strategy
Wal-Mart Stores Inc. and Amazon.com Inc stocks are both solid performers, respectively.
Deciding the structure a portfolio if an investor had to pick one of the two stocks for a period of
10 years is not an easy decision. Any Certified Financial Planner would need to determine the
risk aversion associated with that client. There is not a clear cut solution to the problem.
3.2.
Wal-Mart Stores Inc. Stock as an Investment
Wal-Mart has been a solid investment since the mid 1970's. They are, and remain, a good large
cap stock to hold in a portfolio. The stock has a dividend growth rate of just over 6%, which can
22
http://www.newzoo.com/insights/esports-in-2015-engagement-grows-as-revenues-surpass-250-million/
http://www.tubefilter.com/2015/07/10/twitch-global-gaming-content-revenue-3-billion/
24
http://www.nasdaq.com/article/the-ultimate-retail-war-who-is-winning-the-walmart-vs-amazon-battle-cm535304
25
http://money.cnn.com/2015/10/26/news/companies/walmart-drone-testing/
23
Page | 8
be attractive to many investors. The stock itself can act as a major long run stabilizing force for
any portfolio.
3.3.
Amazon.com Inc. as an Investment
Amazon.com Inc. has shown tremendous innovation and stock growth since their inception in
the late 1990's. Amazon currently has a much higher potential for growth, but has never paid a
dividend to shareholders, and doesn't appear to have plans to change this any time soon.
Amazon continues to innovate and reinvest in the company which is a good reason to not pay
dividends. Along with the great growth potential, volatility accompanies the stock.
Amazon.com Inc.'s beta is on average, 2.5 times higher than the stable Wal-Mart beta of 0.614.
3.4.
Recommendation of Investment Strategy
An intelligent investment strategy would be to invest into Amazon stock and not purchase bonds
that are routinely offered by the company. Amazon’s leadership has shown the willingness to
take on exciting new projects. Some have been successful, and others not so successful.
Nevertheless, they have very capable and intelligent leadership at the helm and show no signs of
slowing down. The stock itself has grown incredibly quick over the past 20 years, and the
analysis performed shows it is still undervalued in the marketplace. Amazon has proven itself to
be a global leader in innovation of new services and products. The potential for continued
success is immeasurable. It would be highly advised to add and retain the Amazon.com Inc.
stock for a long term, high growth strategy component of a well balanced portfolio.
4. SWOT Analysis
The next section focuses on providing a SWOT analysis of Amazon and Wal-Mart. The analysis
highlights the discernible difference between the two companies.
Page | 9
4.1.
Amazon SWOT Analysis
Internal
Strengths
•
•
•
•
•
•
•
•
Customer Base
Available Capital
Data Collection
Strategic Alliances
Delivery Network
GLOCAL Strategy
Strategic Acquisitions
Diversified Products
•
•
•
•
•
Global Expansion
Product Creation/In-House Brands
Acquisition Opportunities
Physical Stores
Acquisition Opportunities
Weaknesses
•
•
•
•
Shrinking Profit Margins
High Debt
Multiple Recent Product Flops
Recent Tax Avoidance Issues
•
•
•
•
•
Low Entry Barriers
Government Regulations
Local Competition
IT Threats
Lawsuits
External
Opportunities
Threats
4.1.1. Internal Strengths

Customer Base: good brand awareness.

Available Capital: can take on diverse projects.

Data Collection: can offer products based on consumers shopping preferences.

Strategic Alliances: logistics providers to control costs.

Delivery Network: provides efficient delivery.

GLOCAL (go-global and act-local) Strategy: used to expand to international
markets.

Strategic Acquisitions: such as Zappos.com and Twich.tv to keep be diversified.

Diversified Products (non-ecommerce): streaming service, Kindle, and Fire products.
4.1.2. Internal Weaknesses

Shrinking Profit Margins: due to the delivery network and price wars from
competitors.
Page | 10

High Debt

Multiple Recent Product Flops

Tax Avoidance Issues
4.1.3. External Opportunities

Global Expansion: opportunities for global expansion from GLOCAL strategy.

Product Creation and In-House Brands: in-house brands in different product
categories.

Physical Stores: outside the U.S.

Acquisition Opportunities: to maintain competitive edge.
4.1.4. External Threats
-
Low Entry Barriers: leads to more competitors equals even less profit margins.
-
Government Regulations: may threaten the way Amazon does business.
-
Local Competition: in global markets.
-
IT Threats: security and safety concerns.
-
Lawsuits: for price gauging.
Page | 11
Wal-Mart SWOT Analysis
Internal
Strengths
•
•
•
•
•
External
4.2.
•
•
•
•
Integrated IT Systems
Acquisitions in UK and India
Customer Base / Brand Loyalty
Low Prices
Wide Product Selection
Weaknesses
•
•
•
•
Thin Profit Margins
Employee Issues
International Penetration
Brand is Associated With Low Quality
•
•
•
•
Increased Competition
Demand For Higher Quality Products
Concern About Ethics
Big Box Store Issues
Opportunities
Expansion to Untapped Markets
Online Marketplace Growth
Inclusion Of Other Services
Strategic Acquisitions
Threats
4.2.1. Internal Strengths

Integrated IT Systems: with international logistics system.

Acquisitions in UK and India: company growth and expansion in the form of new
stores and acquisitions of major retailers in the UK and India.

Customer Base/Brand Loyalty: well recognized brand/customer loyalty.

Low Prices: due to buying in large volumes.

Wide Product Selection: keep the consumer in one place.
4.2.2. Internal Weaknesses

Thin Profit Margins: keep prices lower than competitors.

Employee Issues: turnover and dissatisfaction.

International Penetration: relatively small.

Brand: name of the brand is synonymous with low quality.
Page | 12
4.2.3. External Opportunities

Expansions to Untapped Markets: focus on potential expansion into untapped
markets.

Online Marketplace Growth: online shopping integration with physical stores.

Inclusion of Other Services: from forging of strategic partnerships.

Strategic Acquisitions: smaller companies to further their business plan
4.2.4. External Threats

Increased Competition: in both the retail market and the inexpensive dollar store
market.

Demand for Higher Quality Products: high demand for organic and locally grown
produce has shoppers going to smaller local retailers for their grocery needs which
results in smaller profit margins.

Concern about Ethics: Increased concern on the company’s ethical position on a
variety of topics such health care coverage.

Big Box Stores Issues: stores are not well received in the US and across other
international markets.
Based on the SWOT analysis, Amazon’s strength lies not just in its e-commerce division
but in its online streaming service as well. There is a growing trend of “cord-cutters” who are
cancelling their cable providers and switching to a Web-based service streaming service and
44% of the time these consumers are picking Amazon Prime26. An article on Equities.com
26
http://www.usnews.com/news/articles/2015/07/16/comcast-netflix-and-the-death-of-cable
Page | 13
recently said that, “Amazon is a unique integrated streaming service that can rival Netflix”27.
Amazon has a firm second place behind Netflix with a market share 13% up from 3% from
201428, and is poised to take advantage on the booming industry. The projected revenue from
online video streaming is staggering. A recent article29 mentions that annual revenues from video
streaming and downloads are expected to grow by more than $6 billion between 2014 and 2020.
Figure 4. Projected Video Streaming Revenue
27
http://www.equities.com/editors-desk/stocks/technology/the-death-of-cable-and-the-coming-war-for-the-onlinestreaming-market
28
http://www.geekwire.com/2015/netflix-still-king-of-streaming-video-but-amazon-gaining-market-share/
29
http://www.statista.com/chart/3766/digital-video-revenue/
Page | 14
5. Conclusion
Based on the expected value calculations, the market is undervaluing the stock of Amazon. WalMart’s stock price was calculated in line with market valuation. Wal-Mart needs to diversify its
product in order to compete with the diversification of Amazon. They are already investing
heavily in e-commerce and had a small, unsuccessful foray into the streaming market. Amazon
has already transformed ubiquity into a form of profit. They re-invest their revenue back into the
company further advancing their omnipresence throughout both the real world and the internet.
Therefore, profitability is not all that matters in a company. Maybe in years past, profitability
was the only marker of a company’s success, but in today’s virtual age there are multiple factors
to be considered when looking to invest long-term in a company. A solid strategy and vision for
the company seem to be equally as important as profits. The recommendation for any investor
looking for long term rewards would be to invest in Amazon stock.
Page | 15
6. Appendix
Wal-Mart Beta Information:
Beta Source
Yahoo
Morning Star
Nasdaq
Rueters
Google
Avg.
0.82
0.82
0.71
0.29
0.43
0.614
Page | 16