🔔 Are investors too optimistic about Amazon?

The stock would go on to appreciate 37.8 percent annually in the next four years versus a total shareholder return of 15.8 percent for the S&P 500 Index. That growth translated into an increase in market capitalization of more than $1 trillion.

Amazon will be at a $515 billion-plus sales run rate by the second quarter of 2022 and will have a 6-year sales growth rate ended 2022 of 27.6 percent, if the consensus estimates are accurate.

If Amazon were to pull it off, it would be the most aggressive expansion of a giant company in the history of modern business.

Intangible assets have two characteristics that are important for considering corporate growth rates.

The first is that they can enjoy strong economies of scale because they are commonly cheap to reproduce and share.

The second is obsolescence and the related concept of sunkenness.

The value of intangible assets can drop precipitously when a new and better version comes along and makes the old version obsolete. And because the old version has very limited value, the investment cost is sunk

Economies of scale are a measure of cost per unit as a function of output.

Think of software as an example.

The original code may be very expensive to produce but the cost per unit sold drops rapidly because it is inexpensive to share.

Intangible assets are more scalable than tangible assets.

That means successful companies that rely on intangible assets can grow faster than companies built on tangible assets.

As the overall mix of investments shifts from tangible to intangible, we should expect to see faster growth rates for the winners than we have seen in the base rate data

The right tail (positive outcomes) of the distribution of growth rates is extending outward from the average. Amazon’s results provide anecdotal evidence for this.

We should observe greater variance in the distribution of growth rates for intangible-based businesses. That means that the left tail (negative outcomes) of the distribution of growth rates is also spreading further from the average.

BlackBerry’s 26.7 percent average annual revenue decline in the past decade through February 2021 is a case in point.

This provides investors with good and bad news.

The good news is there will be some businesses that grow in excess of what history would suggest, creating opportunity.

The bad news is some businesses will lose their positions of prominence and decline more rapidly than their predecessors did.

Base rates remain extremely informative, but we must have the mental flexibility to acknowledge how the population of companies has changed over time.

There are two main lessons for investors.

First, it is important to be mindful of the potential shift in the base rate as the result of the rise of intangibles.

Second, skilful investors may be able to identify the companies that will grow faster than expected, hence providing the potential for attractive returns.