Dear Mr. Berko: Amazon.com is getting bigger and bigger, and it is using its huge cash position to buy everything that looks as if it can make money. The purchase of Whole Foods Market and other potential food merchants could really hurt the grocery business because Amazon can sell at lower prices than the competition. In the past two years, we’ve bought clothing, books, all sorts of electronics, sporting goods, outdoor furniture, office products, shoes, jewelry, beauty products, Blu-ray Discs and music CDs from Amazon at prices lower than we could find anywhere else. There seems to be no limit to what Amazon can buy and sell at a profit, and some are saying that Amazon has plans to take on the cellphone business of AT&T and Verizon. With its cloud infrastructure and marketing expertise, Amazon will eventually become the biggest and greatest company in the world and own almost every business worth owning.
I own 100 shares of Amazon, which I bought at $265 a share. If you think my reasoning is correct, would you buy another 100 shares at the much higher current price? I don’t have the cash to do this, but by stockbroker says I could use the Amazon shares I have as collateral in a margin account to buy 100 more shares without coming up with more money. Please answer ASAP. — JR, Jonesboro, Ark.
Dear JR: I applaud your enthusiastic two-page advertisement, which I’ve reduced to about 225 words. Amazon.com Inc. (AMZN-$977.42) is, no matter how you slice the salami, a mighty impressive company. And Jeff Bezos, I’ve discovered, is a mighty impressive CEO. However, I suspect that you recently bought that second batch of 100 shares, are a bit nervous and need affirmation regarding your purchase. The following is an observation from Carl Sagan, an American astronomer, cosmologist, astrophysicist, astrobiologist and author whom I greatly admired. Sagan passed away in 1996 at age 62.
“Consider ... the simple case of a bacterium that reproduces by dividing itself in two. After a while, each of the two daughter bacteria divides as well. As long as there’s enough food and no poisons in the environment, the bacterial colony will grow exponentially. Under very favorable circumstances, there can be a doubling every 15 minutes or so. That means 4 doublings an hour and 96 doublings a day. Although a bacterium weighs only about a trillionth of a gram, its descendants, after a day of wild asexual abandon, will collectively weigh as much as a mountain; in a little over a day and a half as much as the Earth; in two days more than the Sun.... And before very long, everything in the universe will be made of bacteria. This is not a very happy prospect, and fortunately it never happens. Why not? Because exponential growth of this sort always bumps into some natural obstacle. The bugs run out of food, or they poison each other, or are shy about reproducing when they have hardly any privacy. Exponentials can’t go on forever, because they will gobble up everything. Long before then they encounter some impediment. The exponential curve flattens out.”
I’ve admired AMZN and its successes, but its price-earnings ratio’s high-wire act — trading at 125 times earnings while management juggles hundreds of balls (businesses) in the air — scares the bejabbers out of me. If some of those balls begin to fall from that rare height, a potential domino effect could make important investors very nervous. And as AMZN becomes more diversified, the probability of a misstep increases, making it likelier that some of those balls will fall. And because AMZN has become so big, its head may not recognize when the tail has problems, so some missteps won’t be managed till the damage infects the bottom line. The other risk is that in a down market, AMZN will fall more than the market.
At some point, AMZN’s growth will moderate, but it probably won’t be for another three to five years, so there’s probably good lift left in AMZN’s share price. If you understand the risks of a margin account, then have at it.
Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at firstname.lastname@example.org.