Amazon.com, Inc. is the era-defining colossus of a company that has reshaped the way millions of people shop. It is among the few products of the digital age that can claim to have changed its customers’ way of life.

Image: https://goo.gl/images/X7So1W

Has it done the same for its owners?

In terms of price appreciation, a resounding yes. Over the past 10 years, AMZN’s price has appreciated at a whopping 26% CAGR. And in the past 5 years, it has been a cool 30% CAGR.

We at KIP Capital view Price independent from Value. The two metrics have a profound influence on one another, but it is a grave error to confuse the two.

To this end, we calculate Economic Value Creation (EVC) via metrics entirely free from price-related measures. In short, EVC (over any given period) = ▵BookValue/sh + cumulative per share Dividends issued. A detailed discussion can be found here.

Back to Amazon. We chose to focus on the period 2011-2016. And since no dividends were issued during this time, Amazon’s value creation rests entirely on ▵BookValue/sh.

	2011	2016	∆ Change	Grew by a factor of
BV (absolute)	7,757.0	19,285.0	11,528.0	2.5x
BV per sh	$ 17.1	$ 40.7	$23.60	2.4x

The table effectively indicates that every $1 invested in Amazon’s BV/sh in 2011 grew to $2.4 by 2016. Or a CAGR of 19%.

But all growth is not made equal. What is the source of AMZN’s growth in Equity?

First a note on the Balance Sheet: AMZN’s balance sheet appears to follow the 80/20 rule. 80% of the rise in Assets in the past five years are owed to rising Liabilities – two-thirds of which is driven by Current Liabilities. The remaining third was due to Long-Term liabilities, exclusively bank Debt and Other Long-term liabilities.

The remaining 20% of growth in Assets is from the Equity.

AMZN’s per share book value rise was not the result of share buybacks. Quite the opposite. Three-quarters of its BV/sh growth was the result of Additional Paid-in Capital – which is the cash flowing into the balance sheet as a result of share issuances at skyrocketing stock prices. The remaining change in BV/sh is owed to Retained Earnings – which has seen a sudden spike since 2015 owing to Deferred Revenues (CurrentLiabilities) and unusually profitable (3.1% EBIT) 2016 partly due to a near-halved Effective Tax Rate.

Deconstructing Retained Earnings: Only a quarter of AMZN’s BV/sh growth was a result of Retained Earnings. If CFFO is held as indicative of Retained Earnings, most of AMZN’s Retained Earnings are a result of Depreciation, Stock Compensation and Working Capital (CurrentLiabilities). In other words, less than 20% of CFFO of the last five years stems from top-line Earnings of the business. Amazon is infamously low in profitability, with 2012 and 2014 being loss-making years.

What does all this mean?: It means that Amazon.com’s industry-altering idea and near-perfect execution has resulted in staggering Sales growth over the past two decades. An enormous amount of value (both financial and social) value has been produced during this time. And there have been two major beneficiaries of this value: Amazon’s customers and early owners of the stock.

Customers benefited from a seamless online shopping experience and unrivaled low prices. Early owners of the stock have experienced a prodigious rise in stock price as this retail giant scales up within the U.S. and internationally well beyond most investors’ expectations.

The value, however, has not resulted from the Amazon business’s inherent financial success. In the past 10 years, AMZN has had anemic margins and ROICs. AMZN appears to be using its economies-of-scale and network effect to pass on lower costs to the customers as ever lower prices. In the end, only a tiny fraction has ended up in Amazon’s top-line profitability.

Then where did all that value come from? Two sources:

1) Non-interest bearing Creditors like Suppliers, Customers’ upfront payments, and Governments. These are entities extending varying types of credit to Amazon. Most notable among these is Suppliers extending credit in the form of Accounts Payable and Accrued Expenses. This type of ’loan’ is interest-free, also known as float, and has grown three times in size in the last five years.

It is true that these dollars do not flow directly to equity owners and are ultimately owed to the creditors. Part of the cash held as float, however, may be invested during the credit-duration in order to generate future earnings. It is also conceivable that the presence of this float is encouraging AMZN’s inflated valuations (EV/NOPAT ranging from 123x to 750x), producing big returns for continuing shareholders.

2) New shareholders with unending optimism: New owners of Amazon invariably assume another ten years of stupendous growth in AMZN’s future. This fervor allows for the incredible growth in AMZN’s stock price, likely making ex-owners and continuing owners rich.

PIE*: Today’s price implies a 37% CAGR growth in sales ($3.3 trillion by 2027), Operating margin of 1.5%, 50% tax rate, a float injection of $60 bn (negative reinvestments), $9.5 bn in Operating leases as debt, and a WACC of 8%.

Ultimately, AMZN has proven to be a singular vehicle for the Wealth Transfer from the pockets of new shareholders to those of the ex-owners from whom those shares were bought. On what basis are new shareholders buying into today’s inflated valuation? They must assume that this company will continue its astronomical growth, overtaking the online retail space in new international markets – and indeed growing to a $3-trillion plus business by 2027.

Contrast this type of wealth-transferring with a business that creates value through its inherent quality of business. The width of its moat, allowing it a pricing power, lower operating costs or other sticky factors that result in creating financial value for its owners along with social value for its customers.

Unanswered question: Is a Value Transferor really inferior to a Value Creator? Aren’t all great investments ultimately value transferors? Sure, Dividends and Buybacks can happen, but isn’t most of the ‘return’ lying in the Price Appreciation?

*Price Implied Expectations (PIE): The idea behind PIE is to start with the current stock price and use the discounted cash-flow model to ‘read’ what the market implies about a company’s future performance.