Published by Nicholas McCullum on May 14th, 2017
When dividend growth investors look to successful business leaders with the goal of improving their investment skills, one of the last people that would come to mind is Jeff Bezos.
Bezos is the founder and Chief Executive Officer of Amazon (AMZN), a $445 billion technology company with market leadership in the e-commerce and cloud computing industries.
Until recently, Amazon was famously unprofitable and to make matters worse, the company has never paid a dividend. Even if it started paying a dividend today and never paused in growing it, it would take until 2042 and 2067 for Amazon to become a Dividend Aristocrat or a Dividend King, respectively.
This is the exact opposite of what most dividend growth investors are looking for.
What’s notable about Jeff Bezos (and Amazon) is his remarkable ability to do business with an eye on the very long-term. For businesspeople and investors alike, this presents a powerful competitive advantage.
“The single greatest edge an investor can have is a long term orientation”. – Seth Klarman
This article will describe how Jeff Bezos thinks for the long-term and how investors can implement a similar mindset in their personal investment strategy.
Why is Long-Term Thinking Important?
Before looking at Bezos in particular, it is helpful to understand why long-term investing helps investors.
First, long-term investing allows investors to have a greater peace of mind.
When you adopt the intention to hold investments for years (or even decades), you become much less concerned with day-to-day fluctuations in stock prices.
This helps investors to avoid panic selling when stock prices are down (which hinders portfolio performance). It also helps investors to spend time on more productive endeavors, rather than wasting time by fruitlessly monitoring the financial markets.
Long-term investing also helps to defer capital gains taxes.
When an investment becomes worth more than it was purchased for, an investor pays capital gains tax on this difference. However, capital gains tax is only incurred when the investment is sold.
Thus, by holding investments for the very long term, this tax can be deferred indefinitely – a strategy that is sometimes called a ‘Buffett Loan‘, as this strategy hs been put to good use by famous investor Warren Buffett of Berkshire Hathaway (BRK.A) (BRK.B).
Investing for the long term also helps investors to take full advantage of compound returns. Warren Buffett is again probably the best example of this:
“When we own portions of oustanding businesses with oustanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint.” – Warren Buffett in Berkshire Hathaway’s 1988 Chairman’s Letter
Thus, a long-term mentality has the potential to dramatically improve investment performance.
With all in mind, let’s dive into Jeff Bezos’ perspective on long-term thinking.
Jeff Bezos On Long-Term Thinking
Unsurprisingly, Jeff Bezos’ long-term mentality is not some new phenomenon – he has preached long-term thinking since Amazon’s IPO in 1997. In fact, the first subheading in Amazon’s 1997 Letter to Shareholders stated boldly “It’s All About the Long Term”.
The following is an insightful excerpt from that letter:
“We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position. The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital.”
Amazon’s long-term planning encourages thinking about business inputs (rather than outputs). Bezos is notably disinterested in Amazon’s stock price and instead focuses on the fundamental metrics that are the sources of intrinsic value – free cash flow and revenues, most importantly.
Bezos understands that these fundamental metrics are more relevant than quarterly earnings and are driven by Amazon’s long-past investments in future growth. In fact, Bezos recently said to the press that each quarter’s earnings are reliant on actions made by the company roughly three years ago.
Accordingly, this makes it difficult for the company to forecast the next quarter’s earnings or meet sequential analyst expectations. Bezos doesn’t mind – he is more concerned about the next decade, not the next quarter.
This remarkably long time horizon of the company’s founder has led to investors humorously saying that the company operates in the ‘Bezosoic era”.
Humor aside, Bezos’ long-term thinking is academically verified to be rather unique among corporate executives.
The research institute Focusing Capital on the Long-Term (or FCLT for short) is the leading authority on long-term business. FCLT is an experimental institute founded by a group of notable organizations including:
- McKinsey & Co.
- The Canada Pension Plan Investment Board (manages nearly $300 billion on behalf of 20 million Canadians)
- Dow Chemical
FCLT’s mission is to develop “practical tools and approaches that encourage long-term behaviors in business and investment decision-making.”
Interestingly, FCLT surveyed more than 1,000 C-level executives and found that 65% of respondents said that “the pressure to generate short-term financial results” had intensified meaningfully in recent years.
Bezos ignores this short-term mentality. He maintains that most of Amazon’s business successes would not be possible if the company focused on short-term business results.
“If we needed to see meaningful financial results in two to three years, some of the most meaningful things we’ve done we would never have even started. Things like Kindle, things like Amazon Web Services, Amazon Prime. The list of such things is long at Amazon.” – Jeff Bezos in an interview
Without a doubt, Bezos is a proponent of long-term thinking. The remainder of this article will outline how investors can implement this type of long-term thinking into their personal investment strategy.
The Alignment of Shareholders and Customers
Jeff Bezos has long been known for emphasis he places on customer service, something that his first customers found very surprising. Bezos drew criticism in the early days of Amazon.com for allowing negative customer reviews on the website’s product listings.
“One wrote to me and said, “You don’t understand your business. You make money when you sell things. Why do you allow these negative customer reviews?” And when I read that letter, I thought, we don’t make money when we sell things. We make money when we help customers make purchase decisions.” – Jeff Bezos in an interview
In the short-term, it can be tempting to act in ways that are unaligned with the interest of customers.
To counter this temptation, Bezos has instilled a powerful customer focus in the very culture of Amazon. In fact, “Customer Obsession” is one of Amazon’s 14 Leadership Principles. The company’s hiring website states:
“Leaders start with the customer and work backwards. They work vigorously to earn and keep customer trust. Although leaders pay attention to competitors, they obsess over customers.”
For an example of Amazon’s focus on the customer, consider the following example.
Amazon has by far the best selection of any online retailer. The company also has very good shipping time and a user-friendly interface.
Thus, it is reasonable to assume that Amazon could raise prices and it wouldn’t have a meaningful effect on the company’s sales volumes (though absolute dollar sales would increase because of larger ticket sizes). This would benefit Amazon’s shareholders (through higher profits) and harm Amazon’s customers (via higher product prices).
However, this would represent a seismic shift in Amazon’s operating model. Instead of creating value for shareholders, Amazon would be harvesting value from shareholders.
Amazon would be gaining short-term profits in exchange for the erosion of its long-term competitive advantage (low prices).
Thus, it would be a poor long-term business move and it is highly unlikely to ever happen.
So how do investors benefit from applying Bezos’ alignment of customers and shareholders?
Bezos maintains that long-term thinking is the key to aligning the interests of shareholders and customers.
“If you’re long term oriented, customer interests and shareholder interests are aligned. In the short term, that’s not always correct.” – Jeff Bezos in an interview
As an investor, this logic can be applied when searching for high-quality companies to invest in. A company that is always seeking to do what’s right for its customers has a much higher probability of thriving than a company that doesn’t.
One recent example of this is W.W. Grainger (GWW), which recently cut its prices on many SKUs that it delivers through online channels to its business customers. These price cuts have impacted the company’s short-term profits, and its stock price is experiencing downwards pressure as a result.
However, in the long-term, this was certainly the right thing to do for both its customers and its shareholders. If W.W. Grainger kept its prices fixed, it may have made more money in the short-term – but long-term, it would have lost business to cheaper competitors (Amazon being an example).
To conclude, searching for companies that consistently align the interests of their customers and shareholders can help you to invest in businesses with a higher degree of longevity and staying power.
Create Recurring Income Streams
Many of Amazon’s products are focused on selling hardware at a very competitive price, and then locking the customer into some sort of recurring revenue stream (usually Amazon Prime).
Jeff Bezos elaborated on this business model in the following quote.
“Well, our approach to our hardware Kindle devices, Kindle Fire and our Kindle readers, is to sell the hardware at near break even, and then we have an ongoing relationship with the customer where they buy content from us– digital books, music, movies, TV shows, games, apps. And the reason that we like that approach is because we don’t make $100 every time we sell a Kindle Fire HD, since it’s near break even. Instead of making a bunch of money, then, we’re happy if people keep using our products. We don’t have to have you on the upgrade treadmill.” – Jeff Bezos in an interview
Bezos is right – recurring revenue streams have many favorable economic characteristics. They allow for easier forecasting, more predictable expansion, and create a much more recession-resilient business.
Investors can use this knowledge to seek out recurring revenue streams in the businesses they purchase for their investment portfolio.
Large, highly profitable companies like Johnson & Johnson (JNJ), 3M (MMM), and Hormel Foods (HRL) all create products with short lifespans that need to be replaced often. Accordingly, these companies all benefit immensely from the predictability of these revenue streams.
Bezos’ mentality on recurring income streams is also applicable for investors at the portfolio management level – more specifically, on the importance of dividends.
The end goal of most dividend growth investors is to create a dividend income stream that completely covers all of life’s expenses. Thus, investors do well to look for companies with a long history of paying dividends, and a high probability of continuing to pay these dividends long into the future.
To conclude, Bezos is a fan of recurring revenue streams and investors can learn from this by identifying businesses with similar characteristics and investing in stocks with a good chance of paying rising dividends long past the foreseeable future.
Focus on Metrics That Matter
Amazon is often criticized for its lack of meaningful profitability.
Case-in-point: Amazon’s largest per-share quarterly profit occurred in the second quarter of 2016 – an amazingly low earnings-per-share of $1.78.
For context, Amazon’s stock price exceeds $900 at the time of this writing, which is certainly not a bargain relative to the company’s per-share earnings power.
Amazon’s low earnings-per-share begins to make more sense when you investigate the metrics that matter to this company. Amazon does not concern itself with profitability metrics traditional sense.
Rather, Amazon is focused on boosting per-share free cash flow and revenue, as the company understands that its earnings-per-share (the more commonly scrutinized financial metrics) will be constantly depressed due to the substantial investments it consistently makes in new product categories.
Jeff Bezos elaborates on this strategy below.
“Percentage margins are not one of the things we are seeking to optimize. It’s the absolute dollar free cash flow per share that you want to maximize, and if you can do that by lowering margins, we would do that. So if you could take the free cash flow, that’s something that investors can spend. Investors can’t spend percentage margins.” – Jeff Bezos in an interview
Amazon’s focus on revenues and free cash flow can help investors to understand why the company appears so overvalued using the traditional price-to-earnings ratio.
Using a different metric – the price-to-sales ratio – Amazon is actually much cheaper than many of its peers in the large-cap technology space.
Aside from financial metrics, Amazon’s other most important metric – though qualitative in nature – is customer satisfaction. The company collects large amounts of data to measure how well it is serving its customer base.
This data-driven approach to customer satisfaction leads Amazon to spend substantial sums of money on initiatives such as improving website loading times and reducing shipping times (including coordinated same-day delivery).
Amazon’s customer focus is certainly one reason why the company operates with razor-thin margins and low earnings-per-share. The company prices products for its customers, not its shareholders.
“We don’t take the point of view that we’re going to price products at a particular margin for ourselves. We say, ‘we’re going to price products competitively’. If that means on that product we lose money, that’s ok because we need to take care of the customer and earn trust.”
So how can investors apply Amazon’s ‘culture of metrics‘ to their own dividend portfolio management?
Investors should focus on the metrics that matter in their portfolio, and pair this with Bezos’ long-term thinking to focus on optimizing these metrics in the long run.
For each investor, the metrics of importance will be different.
An accumulation stage investor will be focused on total returns. Conversely, a retired investor is more likely to focus on high dividend stocks.
By identifying the metrics that truly matter to your investing strategy and optimizing them over time, you can benefit from a personalized investment approach that is geared towards your individual investment goals.
The potential profits for a company are limited by the competition that it faces.
In Bezos’ view, long-term thinking reduces the competition he faces in the business market. He elaborates on this in the quote below.
“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that.” – Jeff Bezos in an 2011 interview with Wired
Retail investors face a very similar situation. In fact, the quote above is highly applicable to portfolio management.
In the financial markets, active fund managers might seem like they have a huge advantage over individual investors since they have multi-million dollar research budgets and access to alternative investment strategies.
However, individual investors can meaningfully reduce the size of their competitor group by investing with a long time horizon.
With the exception of some hedge funds and endowment funds, most institutional investors are measured by their performance on a quarterly basis. This prevents them from participating in compelling investing opportunities that might take some time to play out.
Individual investors do not face this quarterly scrutiny. If we believe a stock is worth $100 and it is trading at $50, we can buy it without feeling like the spread between market value and intrinsic value must reduce in the current quarter for us to avoid being fired.
So, in short, investing with a long time horizon reduces the competition from our institutional investor counterparts, and allows us to participate in many more investment opportunities that require a longer time horizon.
Amazon is known for being a very frugal company. Employees famously have to pay for parking at the Seattle headquarters (though Amazon reimburses a portion of this), and Bezos himself draws a modest salary of ~$80k from Amazon (with additional costs paid for personal security services).
This frugal culture has existed at least as long as Amazon has been a public company. In the 1997 Letter to Shareholders, Bezos wrote the following:
“We will work hard to spend wisely and maintain our lean culture. We understand the importance of continually reinforcing a cost-conscious culture, particularly in a business incurring net losses.”
For investors, this frugal mindset should be adopting when looking at investment fees.
Unfortunately, many investors are unaware of the adverse effect that investment fees have on portfolio performance.
On the surface, a 2% AUM fee from a mutual fund might not seem significant. This amounts to $2,000 on a $100,000 portfolio – which may go unnoticed if the fund is performing well.
However, it is only by combining frugality with a long-term mentality the importance of minimizing investment fees becomes apparent.
Consider two investors that invest in two mutual funds that average the same gross return (before fees). Mutual fund #1 has a 1% annual management fee, and mutual fund #2 has a 2% annual management fee – double the fee of the first fund.
The two investors contribute $1,000 per month to each mutual fund. Before fees, each portfolio value would be ~$1.5 million after 30 years.
After fees, the story is very different:
- Mutual Fund #1 Final Value: $1.23 million
- Mutual Fund #2 Final Value: $1.00 million
That 1% incremental fee resulted in a ~$230,000 difference in final portfolio value. 1% per year goes a long way after 20 years, and this serves as a useful illustration of the harmful impact of investment fees.
With that said, we recommending avoiding mutual funds. Instead, Sure Dividend recommends long-term, low cost investing in individual stocks.
A large reason why is the annual fee on a directly-owned stock is always zero. Instead of annual management fees, investors pay transaction costs, which are fixed and become much less noticeable as portfolio increases in size.
Amazon is not likely to be on the watch list of dividend growth investors because the company does not pay a dividend. Further, earnings-per-share of $5.32 over the last four quarters indicates that Amazon’s stock is trading at a price-to-earnings ratio of ~174.
However, this is highly intentional – Amazon does not pay a dividend because Bezos would rather reinvest capital with an eye on the very, very long-term. This internal reinvestment drives capital expenditures up, reducing earnings-per-share to extremely low levels.
Bezos’ eye for the long-term has paid off. The company has a ~$445 billion market capitalization – larger than Berkshire Hathaway’s (BRK.A) (BRK.B) ~$403 billion – despite being incorporated in just 1994 (compared to 1839 for Berkshire).
For investors looking to learn from some other highly successful business figures, the following Sure Dividend articles may be of interest: