The continuous rise in Amazon’s share price (see below from Yahoo!) raises in many investors’ minds the question: Should I buy Amazon now, or is it too late? Is there still room for growth of share price, or are all the growth expectations of Amazon “baked” already in its elevated share price?
Traditional valuation indicators used by investors, like the P/E (price-to-earnings) ratio relative to competitors, the PEG ratio (P/E to growth), or the record of the company’s earnings beating the consensus estimate, are useless for Amazon (and, frankly, not very useful for many other companies too). Amazon’s accounting earnings are notoriously depressed by the immediate expensing (charges against income) of its massive investments in future growth (R&D, IT, systems development). In fact, Amazon frequently misses analysts’ consensus estimates with no effect on its share price. Traditional, accounting-based measures are ineffective in reflecting the growth potential of such a fast-changing, highly innovative conglomerate (retailer, web/cloud service provider, platform for third-party sales, etc.).
Perspectives on Amazon’s future growth and the advisability of buying its shares should therefore be obtained from unconventional sources. Here is an important yet largely unknown one:
Amazon is a notoriously secretive company, particularly silent about its development activities. Looking back, these research activities yielded highly successful products (Kindle, Echo) as well as some rare duds (Fire Phone). But what about Amazon’s on-going development activities? Where is Amazon Going? What are its next surprises?
Fortunately, patent laws enable you to peek into Amazon’s elaborate development laboratories, but surprisingly few investors and analysts are pursuing this important venue. Patents filed with the U.S. Patent Office are generally disclosed to the public 18 months after patent application date, and long before the patent is granted (usually 3-4 years) or denied. Every Thursday, the Patent Office publishes on its website the full patent documents for patents reaching the 18-month mark from application. You can see it on the U.S. Patent Office website.
Thus, for example, on March 30, 2017, the Patent Office published a 26-page dense document containing Amazon’s patent No. US2017/0088360 A1 on “Robotic Tossing of Items In Inventory System.” For the visually inclined, the picture below, from the front page of the patent application, demonstrates what robotic tossing is all about. (Yesterday, I received from Amazon a computer tablet I ordered and its cover was slightly nicked, no doubt from the robot tossing.)
These patent disclosures provide investors with a unique opportunity to learn about the highly guarded development activities of Amazon, and many other innovative companies. They can learn about the technological areas the company emphasizes (web-based services, delivery logistics, drones), and the new products/services we could expect from Amazon. Or the markets/industries Amazon attempts to penetrate, and whether these are new or crowded areas or markets.
These are vital clues into Amazon’s growth and continued competitive advantage, much more valuable than the information in financial reports.
Finally, the sad fact about patents is that over 95% of them are totally worthless, ultimately abandoned by their owners. A small minority turn into blockbusters (Lipitor and iPhone patents). So, the value of a company’s patent portfolio is a major indicator of its technological capabilities and growth prospects. But how do you measure patent value?
Economists devised a smart way: Measure the value of a patent by the number of citations to this patent by subsequent patents (forward citations). Specifically, an important part of patent application is its reference list to previous patents and scientific articles which provided the knowledge foundation (“prior art”) for this patent. (Newton said: “I stood on the shoulders of giants”.) Accordingly, a frequently cited patent by subsequent ones is a patent that contributed significantly to the development of science and industry. In a word: A valuable patent.
The following figure compares Amazon’s patents to Google’s patents in terms of average forward citation per patent. Amazingly, from 2007 to 2010, Amazon’s patents were more cited than Google’s, a leading innovator. (The comparison is up to 2010 because you must allow for several subsequent years to collect citations from subsequent patents.) Such impressive technological/innovation capability bodes well for Amazon’s growth. Whether this growth expectation is already baked into Amazon’s stock price is another question.
(Featured Image Courtesy: Business Insider, April 2017. Amazon Logo belongs to respective representative brands. No copyright infringement intended.)