Nuclear Weapons and Contrary Opinion
Big Profits in Amazon.com
My Favorite Stock
We get three newspapers delivered to our office every day, the Wall Street Journal, the New York Times and Investor’s Business Daily. Last Friday, every one of these papers, above the fold, had a picture of Israeli Prime Minister Benjamin Netanyahu, drawing a red line on a cartoon bomb, symbolizing the threat of an Iranian nuclear weapon.
Unless you’ve been living in a cave, you saw one as well.
The fact that these three newspapers used similar photos tells me one thing.
The level of worry about Iranian nuclear power has reached the state where an extreme level of attention is being focused on the problem. Therefore, I can conclude the problem is very likely to be solved. And therefore it’s not something I need to worry about.
Now, this might seem a cavalier, flip, irresponsible attitude. I understand. But it’s an attitude born from years of studying the stock market, and in particular from years of noticing that it’s not the things people worry about that cause trouble, it’s the things people aren’t worrying about, and that they therefore aren’t prepared to cope with.
If everyone’s being thoroughly screened before they board commercial airlines, there’s probably greater danger in charter airplanes, or in ultralight aircraft, like the fellow who got arrested here in Salem for flying his paraglider on September 11. (He wasn’t breaking any laws—there are no laws governing paragliders—but he had to pay $50 in court costs.)
If everyone’s getting flu shots, the flu will not be a major problem. The problem will be one that’s not expected, like beriberi (I like saying beriberi) or excessive exposure to supposedly healthy things like Purrell hand sanitizer or quinoa.
And if everyone’s worried about the Fiscal Cliff, the problem will come from elsewhere, perhaps a Brazilian bank that loaded up on sugar cane futures or a strike by New York City subway drivers (anything is possible!).
In a broad sense, this is contrary opinion, the idea that when the vast majority of people agree on something, they are usually wrong. Contrary opinion is not necessarily a guide to action, but it is definitely a guide to thinking.
So, knowing that there’s little use in worrying about Iran’s nuclear capability, what do I worry about? Well, things that I can have an impact on, like my diet, the tire pressure in my car, the stocks in my (and your) portfolio, and stocks that can be really big winners. More on that below.
Speaking of big winners, today I want to start with a reprint of a Cabot Stock of the Month recommendation I wrote back on March 13, 1998, more than 14 years ago.
Earth’s Biggest Bookstore
“Six years ago this month, a little company called America Online came public, to no great fanfare. A year later, it was running a distant third in the online services industry, trailing deep-pocketed competitors Compuserve (H&R Block) and Prodigy (Sears). But the company focused like a laser beam on its business (unlike the others). It was led by a visionary founder (unlike the others). And it gave away millions of free disks, all in an effort to build the biggest membership base. One year later, it had succeeded in taking a commanding spot as king of the hill, a position it has reinforced ever since. Better yet, for investors, its stock has multiplied six times since it gained that number one spot. Obviously, being number one is much better than being number two.
“And that's why we like Amazon.com! Named for the biggest river in the world, today it's "The Biggest Bookstore in the World. " It has built a loyal following of users, who return often to its website to buy more books. This year it will begin to sell these customers music CDs as well. And beyond that. . . . .the sky's the limit, because while America Online succeeded by selling information, Amazon.com is selling real stuff, and Internet commerce is still in its infancy. “
[This was twelve years ago, mind you. Amazon’s total revenues the quarter before had been just $66 million; earnings were nowhere to be seen and many experts believed that Amazon would be crushed by the giant bookselling experts Borders and Barnes & Noble. Going on in my recommendation, I focused on the inefficiencies of the bookselling industry.]
“The book retailing industry may be characterized by slow growth, but it's a huge business! U.S. sales should hit $30 billion in 2000, while world sales should hit $90 billion. There are approximately 50,000 publishers feeding this market! At anyone time there are some 1.5 million titles in print in the U.S. The average super store stocks fewer than 10% of these titles. And it often overstocks, as it has no perfect way to gauge demand for a book. Overstocks lead to returns, which cost money. And then there's the traditional, and significant, investment in buildings, parking lots, inventory and personnel.
“Amazon.com, by contrast, has minimal inventory. Yet it boasts over 2.5 million titles available, representing every book in print plus a million out of print. Its bricks and mortar are limited to a spartan corporate headquarters and two distribution centers, where distributors like Ingram drop off orders daily, Amazon packages the books, and shippers like USPS and Federal Express pick up their loads. Most books are available at 20%, 30% and 40% off their list price! Yes, competitors like Barnes & Noble and Bertelsmann are to be reckoned with, but we don't think they'll catch Amazon. They're run by book people, not computer people, and Amazon has a big lead.
“Today a lot of people still have never used the Internet. Even more have never bought anything on line. But that's changing fast. In 1996, for example, the company's customers were concentrated among the Internet-savvy, illustrated by the fact that the top-selling book for the year was Creating Killer Web Sites. But in 1997, the top four books were Into Thin Air, Cold Mountain, The Perfect Storm and Angela's Ashes. We still sense a masculine weighting to the audience, but it's obvious the readership is broadening fast.
“Skeptics will tell you the stock is pricey, selling at fourteen times sales and still losing money. And they'd be right … if the company made no progress from here. But every day thousands more people access the Internet and buy stuff. To date, Amazon has captured less than a half of a percent of the U.S. retail book market. The demographic overlap between frequent book buyers and Internet users is high, so we see an immense opportunity for growth in a true mass market. And we think Jeff Bezos, Internet salesman, will achieve it.
“In short, Amazon's success depends on three factors:
• its ability to extend its brand position
• its ability to provide its customers with outstanding value and a superior shopping experience
• its ability to achieve sufficient sales volume to realize economies of scale.”
“For the quarter ended December 31, revenues grew 676% to $66 million, while the loss was $9.3 million, or $.39 per share, up from a loss of $.10 a share the year before. Yet that's acceptable. As explained above, Amazon is following the America Online model, building a customer base first and worrying about profitability second. Some analysts expect the firm to show its first annual profit in 1999. (They didn’t arrive until 2002!) AOL is owned by 173 mutual funds, while Amazon is owned by just 15. The company has no debt. Of 24 million shares, management owns 65%. Founder Jeff Bezos is hanging on to some 40%!”
That investment of March 1998 worked out pretty well. We sold in January, 2000 for a profit of 900%. Doing even better was Cabot Market Letter, which had recommended the stock two months earlier, in January, 1998, and also sold in January 2000, for a profit of 1,291%. That was an awesome sale, because the stock was a huge loser in market selling that followed, falling 95% from top to bottom!
Of course, Amazon eventually recovered (and it’s done very well since), while Borders is bankrupt and Barnes & Noble—despite the success of the Nook—may follow it.
So why do I bring this up today?
Because of a potential parallel. Amazon.com paralleled America
Online in several ways, and a favorite company of mine today parallels Amazon.com in several ways.
It’s Tesla (TSLA) the young electric car company run by Elon Musk, and here’s what I see.
First, Tesla is losing money, just as Amazon did.
Second, its founder is a visionary leader, in the mold of Jeff Bezos.
Third, it’s taking on very large competitors in a large and very established—one might say sclerotic—industry.
Fourth, it’s attempting to succeed in this industry—and to revolutionize it—by doing virtually everything differently.
Tesla is not using gasoline engines. After a century of development, the improvements to be made from gasoline engines are minimal.
Tesla is using batteries, which not only enable superior acceleration and recapture energy upon deceleration but also—because the flat battery is on the floor creates a low center of gravity—enable better handling and more spacious interiors.
These batteries promise no tailpipe emissions. They provide far superior mileage per unit of energy. And they enable better aerodynamics as well; Tesla’s latest offering—the Model S—which seats five adults and two children, is so well designed it has a lower coefficient of drag than any production car on the road today—even the Toyota Prius.
And to date, the cars coming off the line are perfect. Musk is intent that his customers find absolutely no reason to complain about the quality of the product. And to date none have.
Furthermore, the reviews from media, both automotive and mainstream, have been glowing.
Performance-wise, the one shortcoming is the lack of unlimited range that we view gasoline-powered cars as having. But Tesla is working on that (it’s installing a network of chargers in California), and I for one would trade the ritual of stopping to fuel up with gasoline (especially in winter) for a nightly ritual of quickly plugging in my garage, just as I plug in my iPhone every night.
Tesla is doing it differently on the marketing side, as well.
Instead of selling cars through independent or franchised dealers, they’re selling them through stores, overseen by the same guy who designed Apple’s stores!
Now, there are differences between Amazon back in 1998 and Tesla today.
Amazon was growing very fast, while Tesla is not.
Amazon’s stock was shooting higher, while Tesla’s is not.
And Tesla has a government loan to pay back, while Amazon did not.
But that was a different time, when investors were shoveling money into promising stocks, rather than keeping it under the mattress.
And the automotive industry is far more complex than the bookselling industry, so ramping up production takes more time.
Still, I think Tesla has the potential to revolutionize the automotive industry, and thus I think TSLA has the potential to be as big a winner as AMZN was more than a decade ago, and that’s why it’s one of the stocks in the portfolio of Cabot Stock of the Month Report.
I urge you to give it a try.
Yours in pursuit of wisdom and wealth,
Cabot Wealth Advisory