We Study Billionaires - The Investor’s Podcast Network - TIP745: Best Quality Stock Idea Q3 2025 w/ Clay Finck

Starting point is 00:00:00 You're listening to TIP. Each quarter in our Best Quality Idea series, we break down a quality stock, its business model, competitive advantages, valuation, and more. For this quarter, I'll be breaking down to Amazon. Amazon needs no introduction to our audience. For years, we've seen the biggest companies continue to deliver the vast majority of the earnings growth in the S&P 500, and that seems to only continue for companies like Amazon, Microsoft, meta, alphabet, and a few others.

Starting point is 00:00:30 In this episode, I'll discuss why big tech, despite its size, may be systemically undervalued, how Amazon's business model has evolved from a low-margin retailer to a high-margin tech platform, the three megatrends that Amazon is writing, a breakdown of their valuation by business segment, how Amazon's culture of reinvention and long-term thinking positions it to keep compounding, even as it nears a $3 trillion valuation and much more. So with that, let's dive right in. Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most.

Starting point is 00:01:13 We keep you informed and prepared for the unexpected. Now for your host, Playfink. As I was thinking through what company I wanted to cover during this episode, I was taking a look at my watch list, and I keep coming back to this idea of how the internet has enabled some of the greatest companies the world has ever seen. especially from a network effect standpoint. I discussed this in the past during our episode on Booking Holdings,

Starting point is 00:01:47 and we also covered the seven types of competitive advantages a company can have back on episode 727, and network effects have proven to create some of the most scalable business models and one of the most difficult modes for competitors to disrupt. This brings me today to discuss Amazon. Now, I already know what many of you are thinking. You're thinking that Amazon is already a $2 trillion company, how much more could it possibly grow? Isn't it reaching its limits in terms of the law of large numbers and aren't there better opportunities out there? I believe that the opportunity with Amazon is worth considering as they're operating in multiple industries that are absolutely massive.

Starting point is 00:02:30 And their optionality gives them the opportunity to enter new markets that investors don't anticipate today. Their entrepreneurial culture has enabled them to continue to enter new markets, starting with e-commerce, and then expanding to cloud services, digital advertising, Amazon Prime, physical stores, and much more. I'll break this episode down into two parts. The first 20 minutes or so of the episode is where I will discuss the systemic undervaluation of big tech stocks, and in the second segment, I'll specifically be discussing the potential investment opportunity with Amazon. So starting here with the systemic undervaluation of big tech. Since 2010, we've seen the rise of big tech dominate the headlines and take the top spots

Starting point is 00:03:15 within the S&P 500. For years, investors were skeptical that they could keep defying gravity and outperform everybody else. But I believe that the internet has brought about a new era of just how dominant some companies can be. While historically, many industries were more fragmented and would have multiple players competing for market share, the internet has given rise to big tech to create most that simply cannot be competed with to a large extent.

Starting point is 00:03:43 And it creates more of this winner-take-most dynamic in the market. One of the extreme examples of this is in the online search market. So within the online search market, Google has about a 90% market share. It's remarkable and we're seeing a similar trend in other industries as well. Google and meta take over half of the digital advertising market, Amazon, and Amazon, Microsoft, and Google, they captured more than half of the cloud computing industry, and Amazon's captured over 37% of the e-commerce market here in the U.S. These companies are breaking the historical norm of just how big and how dominant companies

Starting point is 00:04:21 are able to get because the internet has enabled them to become aggregators that engulf almost entire industries. Big Tech has forced many investors to rethink the entire investment landscape and how, how they're constructing their portfolios. Since these companies have become so dominant, there's the argument that they have vastly different risk profiles than most companies. Their disruption risk, for example, is typically low, and they're well positioned to continue to grow from these levels. And yet, we see some big tech players trade at or below a market multiple, such as meta and alphabet. Then you look at consumer brand companies like Coca-Cola, Proctor and Gamble, and Johnson & Johnson. These

Starting point is 00:05:04 These companies all trade at similar or even higher earnings multiples, and yet they have inferior business models, weaker balance sheets, lower returns on invested capital, and lower growth rates. When we look at Procter & Gamble, for example, it trades at a PE multiple of around 25, and in the past five years, the share price is up just 23%. And then meta, it trades at around 28 times earnings, and its shares are up over 200% in the past years. Yet, people will look me in the eyes with a straight face and tell me that markets are efficient. One of the biggest fears surrounding big tech over the years has been regulation. You often hear investors worrying that increased oversight or antitrust actions are going to crush

Starting point is 00:05:50 the likes of Apple, Amazon, or Google. But I think the market has been overestimating these risks and here's why. First off, while lawmakers love to talk tough about regulating big tech, the reality is that enforcement is painfully slow and fragmented. It's one thing to make a headline-grabbing statement. It's another to actually pass, coordinate, and enforce meaningful regulation across the U.S. and other markets around the world. Second, these companies have enormous resources at their disposal, world-class legal teams, deep lobbying budgets, and political influence that most companies can only dream of.

Starting point is 00:06:28 This means that they can often shape the rules or even delay regulatory. actions for years. Third, while big tech does often pay fines that sound large, typically in the billions of dollars range, they're really just a rounding error compared to the revenues and cash flows these companies are generating. Rarely do these fines result in the kind of structural changes that would harm their long-term growth. And finally, regulators have no real incentive to kill or hurt big tech. These companies are the technology leaders of the United States. They provide tremendous value to their customers, and they're the top holdings in the portfolios of millions of American investors. Any move to break them apart too aggressively risks harming U.S. innovation

Starting point is 00:07:14 and the savings of everyday Americans, which is something that I think that regulators have proven that they would rather avoid. There's this wonderful article I came across on Substack written by an investor named Nyut, who's a long-term shareholder of Amazon. The article introduced some excellent points to me as it relates to Big Tech. The write-up is titled, The Systemic Undervaluation of Big Tech, which I'll be sure to get linked in the show notes for those interested. The article shares four reasons that can explain

Starting point is 00:07:42 why Big Tech is systemically undervalued that don't have to do with the underlying fundamentals of these businesses. So the four reasons he lists here are first, the 5% rule in the Investment Act of 1940, second, the existing incentives of the investment management industry, third, the availability of growth investment dollars, and fourth, over diversification. So the author argues that your typical investment manager is under-allocated to big tech for these reasons. Many managers are limited as to how much they can concentrate their holdings.

Starting point is 00:08:17 For example, the Investment Company Act of 1940 puts a 5% soft cap on the largest positions of mutual fund can hold for those who seek to market themselves as a diversified fund. There are exceptions to this rule and workarounds for it, but typically, it's just difficult for many of these funds to be overweight big tech. This means that if a fund has, say, a 4% position in META, and over time, shares of META double, this can lead to firms selling down their stake for risk management reasons, even though META's fundamentals might be rapidly improving.

Starting point is 00:08:52 At best, they may be able to hold on to their existence, position and not add any more capital to it for regulatory reasons in order to remain well diversified. Although there are, of course, some funds that are heavily concentrated into the best-to-best companies such as big tech, I believe that these firms are the exception to the rule. You can look at Nick Sleep, for example, who shut down his fund in 2014. He told his investors that he would be putting his own capital into just three companies, Amazon, Berkshire, and Costco. NextLeap is one of the few who have been overweight big tech and it's paid off handsomely for him.

Starting point is 00:09:29 And then the article highlights the incentives within the investment management industry. This should not serve as a surprise to our listeners, but the incentives within the investment industry generally are pretty broken. Active managers need to find a way to justify their fees. And generally speaking, active managers want to find the hidden gems or non-consensus ideas that they hope will produce excess returns. Big Tech is the exact opposite of non-consensus as everyone knows about them, and they're already sizable positions within the index. It's very difficult to raise funds from institutional investors if much of the fund's portfolio is predominantly comprised of very well-understood companies like Big Tech.

Starting point is 00:10:12 If an institution looks at a portfolio that's comprised of a lot of big tech stocks, then they likely feel like you aren't that sophisticated since everyone already knows about, say, Apple and Amazon. If the manager instead owns names that the institutions aren't familiar with, that have this good story or good narrative behind them, then they're much more likely to get the AUM they're seeking. Next, we have the topic of the availability of growth dollars, which I also thought was a very interesting topic here. So usually when a company gets to the size that big tech is, they behave more like mature companies

Starting point is 00:10:47 that have lower growth rates. However, even with big tech being as big as they are, they continue to behave more like growth companies. If you look at Nvidia, Tesla, and Amazon, they don't pay a dividend. They're reinvesting for future growth. When you have companies of this size growing at, say, 20% or more, you can get into the situation where there simply is not enough capital that's looking to invest in higher growth companies. This could be why Coca-Cola trades at a multiple 28, while Alphabet trades at a multiple of

Starting point is 00:11:18 a multiple of 21. Alphabet has just gotten so large that there's a limited amount of capital to push up the share price of a $2 trillion company. Big Tech's heavy investments in growth, coupled with their lack of dividends, hurts their prospects among non-growth investors. Isn't it ironic that conventional wisdom would suggest that companies that pay dividends and have steady growth have saved just 5% per year, they're perceived to be safer investments. Big Tech has brought about a new opportunity to investors who are willing to accept greater volatility in the value of their portfolios in exchange for higher risk-adjusted returns over the long run.

Starting point is 00:12:00 Warren Buffett once shared that he'd rather earn a lumpy 15% return over time than a smooth 12%. This is a similar dynamic with Big Tech. You might get a drawdown of 50% before the stock comes roaring back to new highs. You're not likely to see that in a lot of consumer stable names where the growth is much more predictable. Big Tech, on the other hand, is positioned to grow faster and be much larger companies five to ten years down the line.

Starting point is 00:12:28 Simply put, the third point here is that big tech has simply outgrown the availability of growth investment dollars, which may contribute to the systemic undervaluation. And finally, we get to the topic of over-diversification. In recent years, we've seen much of the overall market's returns come from from the market. big tech, which makes it difficult for your typical manager to outperform because they tend to be underweight this segment of the market. It's really a bit ironic. I've read in a number of fund management letters that the index poses a risk for investors

Starting point is 00:13:00 because of this big allocation to big tech, but the returns over the past five years would suggest the opposite. The index has been quote unquote right to allocate so heavily to these amazing companies. For example, when you look at shares of Amazon, it's compounded at around 17% per annum since the start of 2020. I think most fund managers, when they see their Amazon position going from 3% of their portfolio to 6%, they're likely to trim it down regardless of the business's fundamentals. It wasn't until just recently when we saw Warren Buffett trim his Apple position. Berksler still has a $66 billion investment in Apple, but before he started trimming,

Starting point is 00:13:39 he was really heavily overweight big tech. A growing percentage of the aggregate market cap of all publicly traded companies is shifting towards these big tech players, and much of the incremental aggregate profit dollars and market cap across the universe of listed companies is accruing to these aggregators and platforms, making them an ever larger percentage of the overall stock market index. Managers who are under-exposed to these dominant players are potentially making the game of stock picking even more difficult than it already is. Modern portfolio The audio theory would suggest that you need to broadly diversify, but we should not underestimate just how powerful these big tech aggregators are becoming.

Starting point is 00:14:23 And one other point that I think is worth mentioning here with regards to big tech is how the easy money era plays into these businesses. During the 2010s, the era of near zero interest rates gave Amazon and other big tech firms an open runway to invest aggressively without really worrying about short-term profitability. use this cheap capital to build out an unmatched logistics network, expand AWS, and create an ecosystem of services like Prime and Alexa that have reinforced customer loyalty. Back then, the market rewarded growth above all else, which meant Amazon could run parts of its business at a loss to crowd out their competitors.

Starting point is 00:15:05 But today, that playbook really no longer works. Higher interest rates have made capital more expensive, leaving little room for a new entrant to replicate Amazon's path. With scale, infrastructure, and customer habits now deeply entrenched, Amazon's moat has widened to a point where it is extremely difficult to dislodge it. In a higher interest rate world, it's no longer just hard to compete with Amazon. It's likely economically irrational to even try. I think something similar could be said for a company like Uber as well, which my colleague Sean O'Malley and I discussed back on episode 741. For years, years, Uber was demonized for charging very low rates in exchange for capturing a greater market share.

Starting point is 00:15:49 And the way they fueled this growth was a byproduct of the easy money era. And now today, Uber's the one that's laughing as they've hiked their rates to capitalize on the platform they've built, and now they're just an incredibly profitable business that will be very difficult to dislodge. All right, so let's transition here to specifically discuss Amazon. Amazon's mission is to be the Earth's most. customer-centric company where customers can find and discover anything they might want to buy online. Amazon's one of those rare companies that has completely reshaped how the world shops,

Starting point is 00:16:26 but few truly understand what it was building along the way. For much of its life, Wall Street dismissed Amazon as just another online bookseller that could not turn a profit. But behind the scenes, Jeff Bezos was laying the foundation for something far bigger. He was imagining a future where Amazon could power global commerce entirely. Over the years, Amazon's inventiveness and focus on the customer have allowed it to enter entirely new industries, from cloud computing to entertainment, logistics, and even healthcare. Each bold move seemed crazy at first, yet time and time again,

Starting point is 00:17:02 Amazon has proven the critics wrong. Today, Amazon's business model is less about being a retailer and more about being an ecosystem that touches many parts of our lives. Amazon fits well into these themes we've discussed today because they don't pay a dividend, and despite being a $2 trillion business, they are not afraid to report lumpy results. So to the first point there on dividends, the fact that Amazon is not paying a dividend shows that they're not trying to pander to certain types of investors and attract certain pockets of capital from Wall Street that love a consistent quarterly dividend.

Starting point is 00:17:39 Amazon still has that same focus that they had on day one, which is to obsess over the customer, focus on long-term growth and free cash flow per share, embrace a culture of inventiveness, and not be afraid to be misunderstood. I personally like that they are not paying a dividend because they see the opportunity to instead reinvest that capital to fulfill that vision, providing more value to customers. To the point on being misunderstood, I found this line from a journalist back in 2013, I thought it was pretty funny here, so I'll go ahead and read it off here. Amazon, as best as I can tell, is a charitable organization being run by elements of the investment

Starting point is 00:18:19 community for the benefit of consumers. The shareholders put up the equity, and instead of owning a claim on a steady stream of fat profits, they get a claim on a mighty engine of consumer surplus. Amazon sells things to people at prices that seem impossible because it actually is impossible to make money that way. in the competitive pressure of needing to square off against Amazon, cuts profit margins at other companies, thus benefiting people who don't even buy anything from Amazon. It's truly a remarkable American success story."

Starting point is 00:18:52 So you can sense that the journalist here is saying this a little bit tug-in-cheek, but this is exactly what Jeff Bezos wanted. He wants to be misunderstood because the more misunderstood he is, the bigger lead he can get in the markets he's investing in. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjillo Fjord, and every conversation you have is with people who are actually shaping the future.

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Starting point is 00:23:07 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. The reason that many people believed that Amazon was not profitable is because they were aggressive in their accounting and expensed many of their investments, which led to them showing a net profit that was oftentimes negative. So back to the point about the lumpy results they're willing to report, one of the amazing things about Amazon is just how lumpy their business can be.

Starting point is 00:23:40 If they cared about what Wall Street wanted, then they would try to produce smoother earnings that would just nicely go up a good amount quarter after quarter. The world just isn't that simple, though. And when you're constantly reinvesting in future growth, the best opportunities to reinvest don't always come in this consistent manner. Sometimes the market conditions are ripe for a lot of reinvestment, and other times, maybe not so much. After COVID, for example, Amazon saw a huge boost in their retail and cloud computing business, so they needed to invest more to accommodate that sudden growth and demand. Resisting the institutional imperative and resisting Wall Street's pressure is what has helped allow Amazon to continue to fuel this massive growth

Starting point is 00:24:27 engine and deliver tremendous value for shareholders. They went from strongly free cash flow positive in 2020 to free cash flow negative in 2021, and today they're back to being tremendously free cash flow positive again. And get this, in the trailing 12 months, they did over $100 billion in operating cash flow. Let me repeat that. $100 billion. in operating cash flow, and yet they did not buy back a single share of stock or pay a penny in dividends. They are taking everything they earn and plowing it back into their business. So when you consider the $20 billion in stock-based compensation, they're actually diluting shareholders, which again is going to keep many investors uninterested in becoming shareholders.

Starting point is 00:25:16 And I think there's a good reason for Amazon to continue investing in its business because the Markets it operates in are massive and have huge potential. Today, online shopping represents just 15% of retail sales. The $6 trillion in global e-commerce sales this year is expected to grow to nearly $9 trillion in 2030. Amazon is front and center of this megatrend. In thinking about Amazon's business, it reminded me of the discussion I had around Netflix back on episode 727, where I discussed Hamilton,

Starting point is 00:25:51 Helmers book, Seven Powers. Netflix is the biggest streaming provider with the most users, so they have the most amount of capital to reinvest into new content, which attracts more users. Similar to how Netflix wants to be the go-to service for TV and entertainment, Amazon wants to be the go-to provider of e-commerce, along with a number of other services. Since Amazon has such a high customer lifetime value, they have the most room to reinvest to acquire more customers, provide a ton of value to them through their various offerings, and help build that behavior of becoming entrenched into their customers' lives.

Starting point is 00:26:28 I remember when I was back in college, ordering off of Amazon was kind of a big deal. It's something I did maybe once or twice a month, and it really took some time to build a habit of ordering some things online and have that perception that Amazon was the go-to solution for many of the products that I needed in my life. So here today, where I live in Lincoln, I have a really nice Super Target that's a four-minute drive, and I have a Costco that's a nine-minute drive. So I just bought a new machine to make espresso, and I wanted to go out and buy a new coffee grinder.

Starting point is 00:27:02 Now, I could have easily gotten my car and drove to either Target or Costco, and I'm sure I would have found a grinder that was perfectly fine. But I just didn't want to take out 30 minutes of my day or however long it would take. I hopped on Amazon and I was willing to wait a couple of days for it to get delivered to my door. Of course, the selection and pricing is also part of the value proposition here, but really the biggest thing for me, in this case and in many other cases, is really just convenience. If I wanted to get an item like a coffee grinder within a couple of days, I'm not sure where else I would go online besides maybe directly to a company's website.

Starting point is 00:27:40 Today, purchasing on Amazon is just a part of my daily life. I probably order a handful of things off Amazon a month. I pay $139 a year for Prime to get free shipping. And I really don't even think twice about whether I want to pay for Prime or not. It's just ingrained into my regular routine in my life. When I look across the room at my bookshelf, with hundreds of books on it, practically all of them come directly from Amazon. Amazon's a company that's in this enviable position of being the primary player in

Starting point is 00:28:14 books, and if you think about just how you can extend that to just countless categories, you can see how Amazon is deservedly one of the most valuable companies in the world. We can almost think of Amazon as one of the largest toll road businesses, with their toll being collected on most e-commerce transactions. Whether customers are buying directly from Amazon through their first-party services, where they sell products directly to customers, or their third-party services where the product is sold by an outside entity, Amazon is collecting a fee on every single transaction, and it's typically around 15%, and the profit they make on that transaction tends to be used to make their services even better, further widening their

Starting point is 00:28:58 moat. And Amazon keeps its third-party sellers honest with selling their products at a reasonable price, because if there's substantial margin to capture, then Amazon can potentially release their own version of a similar product through their first-party service, similar to how Costco sells its Kirkland-branded products. One of the things that Amazon has done over the years is make this push for the transition from less first-party sales to more third-party sales. Back in 1999, essentially all of Amazon's e-commerce business came from the first-party sales,

Starting point is 00:29:32 as all these businesses haven't started selling on Amazon since they were just getting started. ever since then, a greater and greater share of their gross merchandise value has come from these third-party sellers. For the first-party sales, Amazon acts as the retailer, buying products wholesale from brands or manufacturers, and then selling them directly to customers. The issue with this is that it tends to be lower margin, and they need to incur the cost of holding and storing inventory. They're putting more and more emphasis on the third-party sales because it's much less capital-intensive

Starting point is 00:30:07 and it has better margins. This transition makes Amazon more of a platform provider rather than a typical retailer. It also makes their business more scalable and less risky, because they don't have to worry as much about which products will sell well and what level of tariffs Trump is going to announce next. If you're a third-party seller, you face the issue of needing to drive traffic, which Amazon, of course, helps solve. Companies could in theory sell their own products on their own website, but then they

Starting point is 00:30:37 the issue of driving traffic to that site, which might make it even costlier than just listing on Amazon and capturing your traffic there. This dynamic inevitably leads to many companies choosing to list their products on Amazon to increase their revenues and grow their business. This two-sided network effect that Amazon has created is something that is extremely valuable, but not necessarily something you would find on the balance sheet. is the number one e-commerce player in the world in terms of both attracting customers and sellers. Today, Amazon pockets a whopping 50% of the third-party sellers revenue, and just five years ago,

Starting point is 00:31:18 that was 40%. This is driven primarily by the referral fees, fulfillment by Amazon fees, and advertising revenue. Amazon is also making substantial progress in delivery times. A higher percentage of their orders continue to be delivered in two days or less, and they're making substantial investments in same-day delivery. This is something that would have been unthinkable 10 or 20 years ago, to think that you could order something online and get it delivered that same day. That is the future that Amazon is creating, and that is just one aspect of why this business is becoming more and more dominant because they're continuing to reinvent themselves and provide more and more value. It used to be that they would lose a lot of money offering that two-day delivery, but once the

Starting point is 00:32:06 demand caught up, they started to turn profitable. The same is happening with same-day delivery. There is not a lot of demand for this, but they're building out that network and anticipation of continued increased demand to eventually make it yet another profitable business segment and expanding their moat. Over the years, Amazon has consistently increased its market share within e-commerce, wide selection, low prices, and fast shipping speeds have made this sort of inevitable. According to numbers I'm seeing from the block MBI deep dives, Amazon's e-commerce penetration in the U.S. was 9% back in 2017, and today it's estimated to be over 16%. So not only are they benefiting from the growth in e-commerce, but they also had the tailwind of continuing to gain share with any commerce, and there's still

Starting point is 00:32:55 plenty of room for them to continue to capture more and more market share. Nick'sly popularized Amazon's model of scaled economy shared, which explains the flywheel of how their focus on keeping low prices brings in more customers, and more customers allows them to offer even better prices and more selection, which creates this recursive feedback loop that is very difficult to stop. With Amazon's big focus on growth, they want that flywheel spinning fast, giving them a bigger and bigger lead over their competition. As Amazon continues to grow, their reinvestments in the Amazon flywheel continues to accelerate.

Starting point is 00:33:33 Prior to COVID, Amazon was spending $10 billion on CAPEX in their North America segment, and in their most recent earnings report, they released CAPEX figures of $10 billion in just one quarter, showcasing their commitment to continue to optimize their shipping speeds across North America. For select Amazon Prime orders in urban and metro areas, Amazon even offers free same-day delivery. As of 2024, same-day delivery has expanded to over 140 U.S. metro areas, and in the top 60 U.S. metro areas, nearly 60% of prime orders were delivered either same day or next day. Amazon also announced plans to roll out same day and next day delivery to over 4,000 small towns and rural locations in the U.S. by the end of 2025.

Starting point is 00:34:23 In their recent Q2 earnings call, they stated, today it's already available in more than 1,000 of these communities across the U.S., their early response from customers in these areas have been very positive. They're shopping more frequently and purchasing household essentials at meaningfully higher rates, end quote. As Amazon continues to reinvest in faster delivery, I can only imagine that their entrenchment in the minds of North American consumers will only grow stronger. Retail is notorious for being one of the most competitive industries, and Amazon has been

Starting point is 00:34:55 one of the few outliers that has bucked the trend of the reversion to the meat. They also discussed how they increased the share of orders moving through direct lanes, where packages go straight from fulfillment to delivery without extra stops by over 40% year over year. They also reduced the average distance packages traveled by 12% and delivered 30% more items same day or next day than during the same period last year. So it's clear that Amazon is constantly working to further improve delivery speeds no matter where customers live. Transitioning here to discuss their advertising business, I really like that Amazon has its advertising business within its e-commerce platform. Given that Amazon's platform is only growing and more customers

Starting point is 00:35:40 eyeballs are landing on their site, it's only natural that they would build an advertising business within that ecosystem. This is a segment that has grown very rapidly. Back in 2019, there wasn't even a report for this product group. And today, this segment is quickly approaching $60 billion in annual revenue, or nearly 9% of total revenue. This makes Amazon the fourth largest digital advertiser in the world. And just as a frame of reference here, Meta currently generates over $160 billion in advertising revenue, and Google Search generates $200 billion in advertising revenue, and YouTube generates $36 billion. From a broader industry perspective, total digital advertising spend is around $750 billion,

Starting point is 00:36:27 and by 2030, that's set to grow to around $1 trillion, making this the second mega-trend that Amazon is well positioned to benefit from. Similar to how most of Costco's operating profits come from their annual membership fees, Amazon really doesn't need to make a diamond profit from their first-party and third-party retail business, as the platform brings in recurring revenue through their prime membership, and they receive high-margin advertising revenue. This gives them a unique advantage over other e-commerce players that don't have that unique privilege. So there are a few other reasons why I really like the advertising business. So first is that it's high margin. Amazon does not report the margins for the segment,

Starting point is 00:37:10 but we do know that meta and Google command high gross margins in excess of 80%. Amazon takes none of the risk in advertising, but takes a disproportionate share of the value because they own the platform. This high margin revenue stream helps enable them to invest tens of billions of dollars into widening their moat. This brings me to the second reason I like this segment, which is because it helps accelerate Amazon's flywheel. Alongside the organic search results, businesses have the opportunity to showcase their product, boosting visibility, which increases competition, selection, and sales on the platform. Sellers are able to see which ads are profitable and convert customers, empowering them to also do what's best for their business.

Starting point is 00:37:55 The rapid pace of growth of Amazon's ad business illustrates just how valuable it's been for advertisers. And finally, the ads business allows Amazon to capitalize on their vast amounts of customer data. As I've touched on with Reddit in the past, as they collect more and more data, these AI models behind the advertising platform rapidly improve, this will make the service more and more powerful for advertisers. The better the AI models get, the more conversions they can drive, which means that advertisers will be willing to pay more for each click, creating a flywheel effect which we're already seeing in motion.

Starting point is 00:38:30 today. So those are a few reasons as to why I like the advertising segment, which I believe is well positioned to grow at a double-digit rate for many years ahead. Since I mentioned Amazon Prime earlier, this is also a pretty significant business segment as it generates around 7% of revenue. Globally, Amazon has around 240 million Prime members. I'd like for the listeners to just take a moment to think about how amazing this is. If the number of Amazon Prime members were a country, it would be the sixth largest country in the world. For comparison's sake, Costco has 76 million global members. Costco's seen as one of the greatest businesses in the world with this massive scale,

Starting point is 00:39:11 which I totally agree with. Jeff Bezos got the idea of charging an annual fee from Costco themselves back in the early 2000s, and today Amazon has over three times the number of members that Costco has. Implementing Prime was a genius decision by Bezos. Prime members shop more often, spend more per year, and are significantly less likely to turn than non-members. In exchange for an annual fee, they get access to free and fast shipping, exclusive deals, streaming content, and more.

Starting point is 00:39:42 It's a value proposition that's constantly being enhanced, which is why their turn rates are very low. This creates a powerful lock-in effect that makes Prime feel indispensable, while simultaneously lowering Amazon's customer acquisition and retention costs. Because of Prime, in my mind, Amazon is essentially synonymous with online shopping. If I need to get a fairly basic item, I go to Amazon. That level of customer mindshare is immensely valuable and is also not something you'll find on the balance sheet. Over the past 10 years, the average annual increase in the cost of Prime is around 3.5%.

Starting point is 00:40:18 So the price has increased at just above the rate of inflation, which to me helps illustrate that Amazon is flexing a little bit of their pricing power. but for the most part, they want to continue to capture as many customers as they can before potentially implementing higher price increases in the future after they've reached an even bigger scale. I haven't touched on the Alexa yet, but this is a device that is estimated to have over 100 million active users. I find myself using an Alexa to set my alarm, start playing Morgan Wallin on my speaker system, setting a timer while I'm frantically running around the kitchen, or get a quick rundown

Starting point is 00:40:55 on the weather for the day. Although the Alexa has not been the smash hit that Amazon hoped it would, it's become a daily utility in millions of households, reinforcing Amazon's presence in the home and deepening customer loyalty, even if it hasn't lived up to its original vision as a driver of voice commerce or meaningful profit. That's why Amazon is now doubling down with Alexa Plus, a generative AI-powered upgrade designed to make the assistant more conversational,

Starting point is 00:41:23 personalize, and offer more features. Early tests have rolled out to over a million users, and Amazon is exploring a paid subscription model as a path to finally monetize the platform. If successful, Alexa Plus could shift Alexa from a basic utility into a true digital assistant and potentially turn one of Amazon's biggest money losers into another profitable business unit. Let's jump here to one of Amazon's most important business segments, which is Amazon Web Services or at AWS. AWS is Amazon's cloud computing platform, offering a wide range of on-demand services over the internet.

Starting point is 00:42:00 It allows businesses, developers, and individuals to access computing power, storage, and other IT infrastructure, without having to maintain physical servers. Not only is Amazon at the center of the e-commerce and digital advertising megatrend, they're also at the forefront of the megatrend in cloud computing.

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Starting point is 00:45:42 Now, cloud computing is an industry that has exploded over the past 15 years. The annual revenue run rate for AWS is approaching $120 billion, and they're ahead of Microsoft, Google, and others in the industry in terms of size. Some investors would say that AWS has bailed out Amazon investors, as it was a moonshot bet that's really become a cash cow as it's incredibly profitable, high margin, and has been rapidly growing ever since its launch in 2006. As Jeff Bezos said, your margin is my opportunity. And before Amazon practically invented cloud computing the way we know it today, companies had to physically store their data,

Starting point is 00:46:23 and IBM and Oracle dominated the market as they had companies purchased service packages. IBM and Oracle fell prey to what's known as the innovator's dilemma as their legacy business earned gross margins of 80% while Amazon AWS earned gross margins of 20 to 30%. Had they launched their own cloud business, they would be disrupting themselves by offering a better alternative, which is the right choice in the long run, but extremely difficult to implement in the short run. This is what's referred to as a counter positioning mode. There were a number of reasons that the cloud was really superfluistic.

Starting point is 00:46:58 superior to the physical infrastructure model, a few of which I'll mention here. First, businesses were able to replace capital expenses with operational expenses. Traditional IT infrastructure required companies to spend large amounts upfront on servers, storage, and data centers. Costs were sunk regardless of how much capacity was used. With AWS, businesses only pay for what they consume, turning IT from a fixed cost into a flexible, utility-like service that scales with demand. Second, businesses would have lower operational costs because of Amazon's scale. Because AWS operates at a massive scale, it can negotiate

Starting point is 00:47:38 better hardware prices, optimize infrastructure, and spread fixed costs across thousands of customers. This translates to cheaper computing power and storage for businesses than they could achieve managing their own data centers. Third, there was no need to estimate future IT capacity, They could just pay for what they use with AWS. This allowed businesses to scale up as fast as they wanted without guessing what their actual use would be. Fourth, AWS allowed software engineers to focus on coding instead of managing infrastructure. Before cloud platforms, engineers spend a large portion of their time provisioning servers, setting up databases, or troubleshooting hardware.

Starting point is 00:48:18 With AWS handling the backend, developers can focus on improving their products. In light of these key advantages, it's no wonder that 60% of the world's business data is now stored on the cloud, and that's set to grow to 70% by 2030. Just a few years ago, Jassy even said that it was the early days for the cloud, and so far it appears he was absolutely right. The cloud market is estimated to be a $750 billion market, and that's expected to at least double by 2030 to $1.5 to $2 trillion. Today, AWS has anywhere from From 1 to 2 million active business customers globally, those 1 to 2 million businesses around the world rely on AWS to help power their business.

Starting point is 00:49:03 AWS has the market leadership within the cloud industry, as they have over 30% market share, Microsoft's Azure and Google Cloud are the number 2 and 3 players. Over the past decade, AWS's market share has remained around this level. And the other thing about AWS is that the computing side of the business has to work as essentially all the time. When there's a surge in traffic, you don't want your website to crash. You need it operating 24-7 all around the world, which means that these companies want to work with a partner that they can trust because without their website, they're nothing. Instead of viewing AWS as Bezos and his crew simply getting lucky and being at the right place at the right time,

Starting point is 00:49:46 how about we view it as a byproduct of their culture that encourages inventiveness, trying new things, and continues to push their limits. When you view it through that lens, you might think that Amazon is well positioned to continue to grow profits well into the future because of that culture that wants to improve, do things a little bit better over time, and figure out new ways to add value to customers. Amazon's ability to buck the institutional imperative and continue to innovate, despite their tremendous size, is really unprecedented. While many companies can get distracted and unfocused by pursuing

Starting point is 00:50:22 multiple initiatives at once, Amazon overcame that challenge by minimizing dependencies among teams and ensuring that each team focused solely on a single initiative. This structure enables Amazon to pursue a large number of initiatives concurrently. Andy Jassy, the current CEO of Amazon, was the driving force behind the creation and launch of AWS. When he launched AWS, he wanted to be the first to the market and get an early lead on the competition. While people like Mark Zuckerberg like to give these extensive presentations hyping up their developments around the Metaverse, Jassy took the opposite approach.

Starting point is 00:51:00 He saw the opportunity with the cloud, and he wanted to innovate and capitalize on that opportunity instead of marketing it to the world about how great Amazon is and how they were going to take over this new market. Because they kept what they were seeing under RAPs, many analysts viewed AWS as a niche experiment rather than something that would be fundamental to Amazon's business model going forward. This allowed AWS to build a massive infrastructure and customer-based before the other tech giants like Microsoft and Alphabet recognized that opportunity. By the time they did realize what was happening, AWS had already established a dominant position which has helped fuel their

Starting point is 00:51:40 market share leadership today. For example, just look at a customer like Netflix. In 2008, Netflix migrated its infrastructure to AWS, and it's their primary cloud provider that powers nearly all their back-end systems. And once all of these companies are on AWS, it's a major headache to switch. This creates a very sticky customer base. And the mode of AWS strengthens as its business grows. The more a customer builds on AWS, the higher the customer lock-in. So not only is Amazon capturing an ever-greater share of the e-commerce market, with AWS, They're also capturing an ever greater amount of spend from all these businesses that are allocating an increasing amount to the cloud.

Starting point is 00:52:25 What's also interesting to me about Amazon's business is how even though they're capitalizing on the growth of the internet through e-commerce and the cloud, their moat is largely in the physical world in the sense that so much capital investment is needed to build out what they've built. AWS is providing all this expensive infrastructure. To compete with them requires an enormous. enormous amount of capital, which is why, say, Microsoft and Alphabet, these are the major competitors instead of, say, a new startup, because that infrastructure cannot be built overnight,

Starting point is 00:52:58 it takes more than a decade to build. The same applies to Amazon's retail business, where they've built out this logistics network of fulfillment centers, last mile delivery operations, and sophisticated robotic systems. This physical infrastructure is also very expensive to replicate. Building a similar retail and logistics network would require billions in investment in years of operational refinement, which further strengthens Amazon's competitive position. When it comes to software, it can be difficult to build out a moat to such an extent. You look at companies like Zoom, for example. Video conferencing was challenged practically overnight with the launch of Microsoft Teams

Starting point is 00:53:38 and Google Meet. Or with the rise of Snapchat, you saw other social media companies launch their own stories feature, just like what Snapchat was doing. Or meta had to all of a sudden compete with TikTok, which is now a global powerhouse in the social media space. So AWS, they have 30% market share in cloud computing. Once this market position has been established, they're also a toll collector on the internet. Software businesses rise, software businesses fall, but no matter who wins, Amazon collects

Starting point is 00:54:09 their fee with the ever-growing traffic on the internet. And then something else that also took me some time to read. realize was that the retail business in AWS can actually play into each other quite well. First off, Amazon does not need to pay a third party for cloud services. They can just use AWS. This provides them with cost savings relative to other retailers. They can also optimize their infrastructure for use internally for their specific needs. AWS was initially used for Amazon's retail business and it was then spent off as a product that other companies could use. So today, they could test new products or cross-selling opportunities in the retail business

Starting point is 00:54:49 or within one of their other segments before offering it within the AWS product offering and ecosystem. So turning here to the valuation, due to the vast complexity of Amazon's business, I'd like to try and keep this section fairly simple and straightforward. I think the most important thing here is that Amazon is just a great business run by honest and capable people. If you're investing for the long term, it's really important that you get that right. We also, of course, want to be sure that we're getting a reasonable entry price when you're

Starting point is 00:55:20 taking that position. As of the time of recording, Amazon trades at around a market cap of $2.3 trillion here in August 2025. For the purposes of this discussion, we can think of Amazon as having four distinct business segments. We have the retail segment, advertising, subscriptions, which is mostly Amazon Prime, but also includes things like Audible, Kendall, and others. And then, of course, we have AWS. My colleague, Daniel Manka, who co-hosts the Intrinsic Value Podcast here at TIP, he put together a model I used in getting a

Starting point is 00:55:53 better understanding of Amazon's intrinsic value. I'll be sure to get that linked in the show notes for those who would like to plug in their own numbers, their own assumptions, and come to their own assessment of Amazon's intrinsic value. Sean O'Malley and Daniel Munka also put out an episode of their own about Amazon on the Intrinsic Value podcast, which I'll be sure to get linked in the show notes as well. So starting with AWS here, this business generates $117 billion in run rate revenue. I expect this segment to grow in the mid-to-high teens over the next five years. If they're able to achieve this, I expect this segment alone to be worth around $1.4 trillion dollars today. If I'm correct in my assessment of AWS, this would mean that this one segment

Starting point is 00:56:36 accounts for more than half of the value of Amazon. Turning to the retail segment, I expect this segment to grow in the mid-single digits over the next five years and for more of this business to continue to transition to third-party services, which has higher margins and is thus more valuable from a business standpoint. In aggregate, the retail business is set to generate around $500 billion in revenue in 2030, and after applying modest operating margin assumptions, I come up with an intrinsic value for this segment of around $400 billion. Transitioning to advertising, this segment is growing very rapidly, its high margin, and generating a ton of value for shareholders. I modeled out mid-to-high-teen's growth for the next five years

Starting point is 00:57:20 in operating margins of 35%, which is in line with Meta and Google, giving us an intrinsic value of nearly $600 billion. And then finally, we have the subscriptions business, which I primarily think of as Amazon Prime. I modeled around 10% growth in revenue here for the next five years as they continue to expand internationally and implement price increases. This gives me an intrinsic value just shy of $300 billion. Adding these together, we get an estimated intrinsic value of Amazon at around $2.8 trillion, which is intended just to give me a general idea of how optimistic or pestil,

Starting point is 00:57:56 the market is on Amazon, relative to my expectations. As of the time of recording, the market cap is 2.3 trillion, which implies that the market is not as optimistic about Amazon's future as I would expect it to be, which might mean that the stock is slightly undervalued should the future pan out how they like it to, and this assumes that none of the four segments are majorly disrupted. One thing that my model does not take into account is the possibility of Amazon creating entirely new business segments in the future. Although we don't necessarily want to bank on management continuing to pull rabbits out of the hat, like they did with the AWS in the Amazon Prime,

Starting point is 00:58:35 we don't want to entirely roll it out. One of my favorite quotes from Morgan Housel is that the biggest risk is the one that no one sees coming. Instead of viewing this from a negative lens, we could also view it from a positive one. What if Amazon has a trillion-dollar business currently in the works that will be known by everybody 10 years from now? but is known by practically nobody today. Similar to Alphabet, Amazon has a segment where they test new ideas that have the potential for an exponential payoff similar to what happened with AWS years ago. Since Amazon does not provide much for disclosures for this segment, it can be easy for the market

Starting point is 00:59:12 to potentially underestimate its long-term potential. One potential candidate of a successful moonshot bet is Project Kuiper. Project Kuiper is Amazon's initiative to build a constellation of low-orbit satellites that deliver high-speed, low-latency internet to underserved and remote areas around the world. The plan involves launching over 3,200 satellites with service expected to begin rolling out by late 2025. It's seen as a direct competitor to SpaceX's Starlink, targeting both consumers and enterprise customers, including governments and telecoms. Amazon views Kuiper as both a commercial opportunity and a strategic infrastructure layer to support its broader ecosystem, including

Starting point is 00:59:57 AWS and retail operations. The company is committed over $10 billion to the project and is building a dedicated ground infrastructure and satellite production facility to scale it globally. With the rise of AI, it's not hard to imagine scenarios where Amazon benefits massively from improving technologies, from warehouse automation to personalized shopping experiences and voice-enabled commerce through Alexa. AI can enhance nearly every corner of Amazon's flywheel. Amazon is also embedding generative AI into AWS products,

Starting point is 01:00:33 helping developers build smarter applications and positioning itself as a key infrastructure provider in the AI arms race. And with billions invested into companies like Anthropic, Amazon isn't just adopting AI. They have stakes in other companies that are at the forefront of innovation in AI. At around $220 per share, I believe that investors are getting an excellent company at a fair price. Investors aren't going to get rich quick off it, but I would expect investors to see a modest return at this century price. A fundamental law of capitalism is that over a long

Starting point is 01:01:08 enough time horizon, all companies are bound to die. Amazon has proven to be one of the best at extending its growth runway as long as possible in delaying their inevitable death. Bezos has publicly discussed the idea of Amazon's eventual failure, emphasizing that no company is too big to fail and that Amazon, like all companies, will eventually decline and cease to exist. He uses this perspective to motivate Amazon's employees to constantly innovate and avoid the complacency that he believes leads to stagnation and failure. Eventually, there will be a day when Amazon is no longer the growth machine that it is today, But I don't think that day is coming anytime soon.

Starting point is 01:01:53 As long as the company continues to reinvent itself, focus on providing value to customers, and operate with the urgency of a startup rather than the comfort of an incumbent, I think shareholders are in good hands with this company. Just prior to this episode's recording and release, Amazon announced is results for the Q2 2025 quarter, which sent the stock down by nearly 10%. Topline revenue for the quarter grew by 12% after adjusting for 4%. foreign exchange rates, AWS grew by 17%. Their incremental revenue added was their second largest ever for the quarter.

Starting point is 01:02:29 In the report, CEO Andy Jassy stated, Our conviction that AI will change every customer experience is starting to play out as we've expanded Alexa Plus to millions of customers, continue to see our shopping agent used by millions of customers, launched AI models like Deep Fleet, that optimized productivity pass for our 1 million plus robots, made it much. easier for software developers to write code, launch strands to make it easier to build AI agents, and release Bedrock Agent Corps to enable agents to be operated securely and scalably. Our AI progress across the board continues to improve our customers' experiences, speed of

Starting point is 01:03:08 innovation, operational efficiency, and business growth, and I'm excited for what lies ahead, end quote. Overall, I think it seems to be business as usual at Amazon, but the likely reason for the stock falling is because of the lower than expected growth for the AWS segment. While AWS grew by 17%, Microsoft Azure reported 39% growth, and Google Cloud reported 32% growth, which isn't exactly in Apple's to Apple's comparison, since AWS is much bigger than the other two players, but it's quite clear that Azure is gaining share on AWS, and thanks to OpenAI, Azure has the advantage of capturing AI workloads. Google Cloud is also gaining share, and their cloud segment also seems to be well-positioned

Starting point is 01:03:54 to benefit from the AI world we're entering. On the bright side, in their earnings call, they talked about how they have more demand than they have capacity for at this point, and their biggest constraint is power. Because AWS cannot keep up with demand, Amazon continues to reinvest significantly to try and keep up. In the retail segment, we continue to see margin expansion in both North America and international markets. In an update published by mostly borrowed ideas on Substack, they write, I continue to think Amazon retail is underestimated. While Amazon is never going to be a monopoly in retail, it's hard to imagine why they won't be a headwind to most physical

Starting point is 01:04:35 retailers over the next few decades as the convenience of ordering something, which magically appears on your doorstep in a couple of hours is a timeless value proposition, end quote. I really have a hard time disagreeing with them there, and I feel that's a good place to close out this discussion. If you enjoy this episode and have any thoughts or feedback, feel free to shoot me an email at Clay at the Investorspodcast.com or tweet at me on X at Clay underscore Fink, C-L-A-Y-U-N-C-K. Thank you for tuning in to today's episode on Amazon. It's because of loyal listeners like yourself that I have the opportunity to put together this content and put it out into the world for free. With that, we'll close it out there and I hope to see you again next week.

Starting point is 01:05:21 Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to The Investorspodcast.com. This show is for entertainment purposes only, before making any decision consultant professional. This show is copyrighted by the Investors podcast network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP745: Best Quality Stock Idea Q3 2025 w/ Clay Finck

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