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Technology Stocks : Amazon.com, Inc. (AMZN) -- Ignore unavailable to you. Want to Upgrade?

To: Glenn D. Rudolph who wrote (9300)	7/7/1998 8:50:00 PM
From: umbro	Read Replies (1) \| Respond to of 164684

FOOL ON THE HILL An Investment Opinion by Dale Wettlaufer Revenge of the Dollar Machine Yesterday, I wrote about Amazon.com (Nasdaq:AMZN - news) , which has been a source of endless fascination for me. The valuation challenges it presents have obviously bamboozled the short-sellers for the last hundred points or so, partly because it's hard to price companies that are in their hypergrowth phase. It's much less of a challenge to price something that is returning 15% on equity with no leverage than it is to price something that is generating losses but that is growing revenues 30% sequentially. Once again, though, there is a touchstone that investors should return to. It's called intrinsic value. No matter what the situation is now, whether it's a steel manufacturer, aerospace company, electronics manufacturer, or insurance company, it has an intrinsic value. The term "intrinsic value" has gotten more than a few people hung up worse than a golf ball in heather and gorse. It might be helpful to review what intrinsic value means. Randy Befumo wrote about this last year in great three-part series (Part 1, Part 2, Part 3) entitled "The Dollar Machine." Imagine if you had a machine that you knew would spit out dollars. If you knew that it would spit out a dollar per year for ten years each year on New Year's Day, and it cost nothing to maintain that dollar machine, coming up with a price to pay for the dollar machine wouldn't be very hard. If it were guaranteed to spit out those dollars, it would probably be priced to yield the same return on investment as a 10-year federal government bond (assuming someone wouldn't bid the price higher, and thus the yield lower, because a dollar machine is so cool to have). If the current interest rate on a new 10-year bond is 5.41%, then you'd be willing to pay $5.90 for the dollar machine. That's because your $5.90 will turn into $10 at the end of year 10 if you reinvest your interest income at a rate of 5.41% until the end of year 10. The intrinsic value of the thing is $5.90. No more, no less. Unless you had a religious or Freudian hangup about the dollar machine. What someone else bid for it doesn't change the intrinsic value of it. The new bid changes the market price of the thing, but not the intrinsic value of it. If there were a change in interest rates, then intrinsic value would change. That's because an investor's required rate of return from the dollar machine would change. Assuming that there's no premium paid for owning something so cool and assuming there's no discount that would have to be ceded by the seller because the buyer thinks the machine is the work of the devil, the investor will require the same rate of return from the dollar machine as a government bond would yield. Imagine the dollar machine as a convertible preferred stock, a factory, a venture capital investment, or a blue-chip common stock. All of these have different expectations of rate of return because of the uncertainty of the return of dollars to the buyer. If there was no uncertainty and you had an absolute guarantee of the return, then none of these different asset classes would carry a different yield than the government bond. Venture capital investments yield more than government bonds because people are pretty sure the U.S. government will be around and paying off the principal in ten years. Lots of venture capital investments blow up and die, some muddle along, some do well, and some make people spectacularly rich. It's the uncertainty of the returns to shareholders that creates a higher-risk, higher-return asset class. It's not anything else. If you know for sure how many dollars this machine is going to spit back at you, then it's not going to be priced any differently than a government bond. If you and everyone else knew for sure in 1986 that Microsoft were to be around and worth a certain dollar amount per share, then there wouldn't have been a venture capital-like rate of return to Microsoft (Nasdaq:MSFT - news) shareholders over the last 12 years. Rather than coming public at a split-adjusted $0.29 per share, if the company were priced at its intrinsic value, it should have been priced around $27.70, or 56.6 times its IPO price, assuming a bond with 12 years to maturity at that point was yielding 12%. Dividing the current market price of Microsoft, $107 15/16, by the intrinsic value IPO price of $27.70 yields a product of 3.89666. The 12th root of that number is 12, or 12%. This is all provided that you know for sure what will happen in the future. The reason market prices vary is because there is uncertainty. No one knows what will happen. Some people have excellent insights, and some people thought that ZZZZ-Best and Centennial Technologies (one a criminal stock scheme, the other a seemy situation at best -- I'll let readers figure out which is which) were the next great things. It's because of excellent insight that Bill Gates didn't sell all his stock in 1986 or 1996, even. It's because of excellent insights and conviction in those insights that any number of great investors have exceeded the performance of the market at large. Speaking of excellent investors, Warren Buffett said all of this more succinctly in a talk with Bill Gates at the University of Washington earlier this year. That talk is transcribed in this week's Fortune magazine. Here's Buffett's thought on the matter: "I think that there's no magic to evaluating any financial asset. A financial asset means, by definition, that you lay out money now to get money back in the future. If every financial asset were valued properly, they would all sell at a price that reflected all of the cash that would be received from them forever until Judgment Day, discounted back to the present at the same interest rate. There wouldn't be any risk premium, because you'd know what coupons were printed on this 'bond' between now and eternity. That method of valuation is exactly what should be used whether you're in 1974 or you're in 1998." source: fnews.yahoo.com