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Netflix and Amazon each have the right mix of great management, execution and growth potential, and their strategy of re-investing so much of current profits into future growth is smart. (MIKE BLAKE/REUTERS)
Netflix and Amazon each have the right mix of great management, execution and growth potential, and their strategy of re-investing so much of current profits into future growth is smart. (MIKE BLAKE/REUTERS)

STRATEGY LAB

Why Amazon and Netflix are set for more gains Add to ...

Chris Umiastowski is the growth investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

It’s earnings season on Wall Street, when sell-side analysts work at a frantic pace to provide clients with instant assessments of what the latest revenues and profits will mean for stock prices.

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I’m glad I’m no longer one of those analysts. I left Bay Street almost three years ago, which means I can now spend more time thinking about what matters for a company’s long-term performance. The freedom is liberating.

I no longer obsess over a spreadsheet, trying to figure out how the latest quarter’s results will shift the stock price tomorrow. Instead, I can look at a business’s overall strategy.

Consider Amazon.com Inc. and Netflix Inc., two companies in my Strategy Lab growth portfolio, which both reported results last week.

Both stocks have done very well over the last several years. But I think the market is underestimating what the next few years may hold.

In Amazon’s case, the company is investing heavily in distribution centres for physical products. Most people think of Amazon as a vendor but it has arguably built the most sophisticated fulfilment operation on the planet. This gives it enormous power.

If you want to start a business that sells goods online, Amazon is the easiest way to move your product. It now occupies the same position in online selling that credit card companies hold in electronic transactions. Credit card companies take a fee for every transaction, while Amazon takes a fee for every physical product it moves through its warehouse on behalf of a third-party seller.

Amazon generated nearly $5-billion (U.S.) in cash flow from operations over the last 12 months, and CEO Jeff Bezos seems happy to re-invest much of this money back into growth. Given that sales jumped 24 per cent in the third quarter compared to last year, it’s hard to argue with the man.

I’m particularly impressed that Amazon’s growth strategy doesn’t end with physical goods. It’s building data centres to support its cloud computing business, which offers a huge variety of computing resources that any online user can tap on a pay-as-you-go basis.

Netflix (which we’ll get to in just a minute) is an example of a multi-billion-dollar service running on top of Amazon’s cloud computing infrastructure. Dropbox, the file sharing service, also runs on Amazon's cloud. So does Evernote, which offers personal productivity software.

Lots of small businesses also use Amazon’s cloud for their digital infrastructure. The service is cheap, reliable and accessible to any business that wants to use it, no matter how small its needs may be.

Relative to the physical goods that Amazon is best known for, the cloud business is tiny. It makes up less than 6 per cent of Amazon’s total sales, and is buried in a segment called “other”. But that segment still hit $1-billion last quarter, and grew 58 per cent year over year.

Selling computing cycles, storage and bandwidth is likely a much higher margin business than selling electronic goods or diapers. And it has enormous growth potential. I think it’s smart of Amazon to invest in this business now, making it very difficult for anyone else to compete on scale.

Netflix also re-invests a huge chunk of its profits into growth. This giant in streaming TV shows and movies spends plenty of cash on producing its own content, buying new licenses for popular content, and expanding into new geographies. I think this geographic expansion is a big deal for the business in the next five to 10 years.

In the meantime, growth in the core U.S. market isn’t anywhere close to peaking out. Its U.S. subscriber base grew an impressive 26 per cent in the last year, reaching 30 million households.

And if you think U.S. growth is strong, check out the international segment, where Netflix now has over 8 million subscribers representing a whopping 190 per cent growth over the last year. Yet the company has only just launched in major markets such as France and the Netherlands, and still has much of Europe and Asia to expand into.

Netflix and Amazon will seem expensive to anyone looking at the stock chart, but I believe both companies have the right mix of great management, execution and growth potential. Their strategy of re-investing so much of current profits into future growth is smart. I think both stocks will beat the market over the next 10 years.

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