In this episode of Industry Focus: Tech, Motley Fool analysts Dylan Lewis and Ben Ra take on some listeners' investment questions. They take a look at some e-commerce companies and what is working for them and what the future might hold for them in terms of growth. Learn how to balance your portfolio with allocation tips and much more.
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This video was recorded on Feb. 28, 2020.
This video was recorded on Feb. 28, 2020.
Dylan Lewis: It's Friday, March 20th, and we're dipping into the mailbag. I'm your host Dylan Lewis and I'm joined by Motley Fool Premium analyst Ben Ra. Ben, how's it going?
Ben Ra: Excellent. I'm happy to be here.
Lewis: Yeah, it's great to have you back on the show. I think last time we did a show together, we were talking about China. Today we are answering some questions. We got some questions built up in the mailbag. The mailbag is getting a little bit full, and I love that, because we are pre-recording this episode. I'm going to be on vacation when it airs. So, there might be some numbers that are a little different, especially as we're talking about market cap, but the mailbag episodes are great because we get to talk about concepts, and really, concepts don't ever get stale.
So, we have a couple questions we're going to be hitting on this episode. And of course, listeners, if you want us to hit anything, just write into the show, IndustryFocus@Fool.com or you can tweet us @MFIndustryFocus, we love getting ideas.
So, our first question comes from Kim. Kim asks, "What do you see as the eventual size of the e-commerce companies, and where will they be in five years? (Amazon (AMZN 3.15%), MercadoLibre (MELI 3.62%) and JD (JD 2.69%))". So, three companies, three very different companies when you look at that list.
Ra: Yeah, I mean, Amazon really stands apart, and it really should be treated, I think, differently from the other. Amazon, first of all, is a trillion-dollar company, MercadoLibre is way smaller, it's like $30 billion, $40 billion and then JD is probably around twice as big as that. So, you're talking about a different scale here, a trillion-dollar company. So, if you're expecting, say, like a 15% return on Amazon over the next, say, four years it's going to double. So, it's going to be a $2 trillion company in around four years, if the stock returns 15% a year, which is a pretty good return, but it's also $2 trillion. And it's probably going to be 10% of U.S. GDP.
Now, is that impossible? You know, anything is possible, and maybe I'm just not being enough of a visionary, and the trillion is probably what a billion was a hundred years ago. And I would imagine that back in 1900, the first billion-dollar company -- and I actually looked this up, it was U.S. Steel, around the 1900. And I'm sure that when that happened, it was a shock for a lot of people, but at the same time, the GPD at the time was around $600 billion. So, the market cap of U.S. Steel at the time $1 billion, right-around, was like 0.16% of GDP, whereas you're talking about $2 trillion versus about $21 trillion of GDP. So, it's closer to 10% of GDP, it just shows you how much bigger these companies are as a percentage of our total economy. I'm not saying it's impossible, but I tend to take the under on that.
Lewis: Yeah, that's a hefty valuation. And you know, in fairness, we saw Apple hit $1 trillion. And depending on when you looked over the last couple of months, $1.4 trillion was around when they were trading at. And so, they hit that 40% upside fairly quickly. It is tempting to think that winners will keep on winning, and I don't think that anyone can really go wrong by owning shares of Amazon. But the bigger a company gets, the more you have to adjust your growth expectations.
Ra: Sure, absolutely. And the thing about Amazon and also the other successful e-commerce companies, like, MercadoLibre, for example, or Alibaba, is that, they're not just e-commerce companies. E-commerce is, in a way, you know, just one part of their business. And I actually think that, being a first-party retailer, where you're buying stuff that you're selling online, is not a very good business. You know. Amazon, of course, there's AWS. Cloud business is just a huge part of that valuation. It could be like 50% of that valuation. MercadoLibre, of course, you have payments. Alibaba, it's really like a search engine for retail. You have Alipay, which is their payments platform. So, you have other businesses that they've been able to leverage. And that's really the question that you have to ask when you're thinking about a JD.com or any other e-commerce companies, what else besides just selling stuff can they actually do?
Lewis: And for Amazon, I mean, that really starts to enter into the, "Will regulators come at them?" kind of, angle. And we talked about this on the show before, I would not be shocked if in the next five years, maybe next ten years, Amazon looks a little different as a company than it currently does. And you mentioned that AWS segment, a lot of people think that could be spun-out at some point.
Ra: Absolutely. Yeah, I've heard a lot of people say that, and a couple of our analysts actually believe that too. It's definitely possible, I think a lot depends on the next presidential election; who knows where that will take us. But it's definitely not impossible for that segment to be spun-off. That's a possibility that it's really in the future.
Lewis: So, to play devil's advocate a little bit, you know, you're giving the difficulty of getting from a $1 trillion to a $2 trillion company, and I don't know that it'll happen overnight by any stretch, but I think what's so tempting about it for investors is, while you look at e-commerce and that's really what Amazon's known for, and the penetration rate is still so low in the United States. I think, depending on the estimates you look at, it's somewhere in the low double-digits of overall retail. And I think Amazon's take on that is, like, 35% roughly. And so, you say, wow! If more and more of those purchases start coming online, there's going to be some pretty big tailwinds pushing this company forward.
They're also seeing that market share of online sales dip a little bit over time. They used to be 50%, now we're seeing them down to mid-30%.
Ra: Yeah. And you know, that percentage of online sales will probably -- I would say it's going to go down in the future, but yeah, as you said, you know, online sales generally I think it's going to increase. So, yeah, I mean it's just one of those things where it's very difficult to predict. A $1 trillion, for me, is a huge number still. It's difficult for me to imagine $2 trillion, but you know it's probably going to happen, so.
Lewis: To look at some of the smaller companies, though, I think the growth story is still so intact. MercadoLibre is a company that I've talked about plenty on the show, and I mentioned the penetration rates for e-commerce before, you go down to South American and look; I think it's, like, maybe 3% or 4%. So, they're still coming online with so many of their purchases, so many of their payment options. I have to think there's a little bit more green space ahead of that company.
Ra: Yeah, absolutely. And these are all economies -- you know, China is in a way similar. In the U.S., you have this built-out retail infrastructure, you have companies like Walmart, you have companies like Costco, that have just been powerhouses for a long time. So, Amazon really has to compete against these kinds of tough competitors. They're not just going to lay down for Amazon, no matter how great Amazon is.
But it's not the same in South America, it's not the same in China. There it's much more, say, it's much more virgin territory. So, with their powerful online, digital, cloud-driven business models, they can do a lot more damage than Amazon can do here in the U.S. Of course, they're smaller economies. Well, China is big, but South America is smaller. But they could definitely take up a huge share of that economy.
Lewis: And there's kind of a different element too with consumer behavior and just where people are in terms of their financial lives, you know, I mean, Amazon is, for the most part, an e-commerce platform for a lot of people, but if you go down South America, you're seeing people use MercadoPago as a payments infrastructure. And that's something that Amazon doesn't quite have. And that's a wonderful kicker for digital payments for them. It started out as something that they just wanted to be able to process things on their own platform, it turns out, they basically created the PayPal and Square of South America. So, there are different drivers there, but at the same time, they don't have the cloud business that's putting up crazy margins that Amazon gets to enjoy.
Ra: Yeah, I mean, e-commerce, Amazon, if you look at how they've performed internationally, they've done alright in places like Europe, but I mean, if you go to South Korea. China, of course, is pretty much blocked for them. But I mean, they really don't have that much market share. It's a little different with the cloud business, with the cloud business, they've actually been able to get a very high market share internationally, whether it's in South America or in Asia. So, there is something about that business where they're just able to dominate internationally, and not just in one area which is sort of the case with e-commerce, where it's very regional.
Lewis: Yeah. I think what Kim probably wants out of this conversation is something that we aren't going to be able to give Kim. I'm assuming he, but sorry, if that's the case, she. And that's, you know, what do these businesses look like in terms of market cap in five years? I think we would be loathed to throw out a number, but what I hear throughout this conversation is, the huge tailwinds that a lot of these companies have and the fact that they are still pretty much in the early innings, certainly the trends and also these companies within the trends.
Ra: Yeah, absolutely. And if you just diversify with these, you really can't go wrong, I think, buying these companies, as long as you hold them over the long-term and as long as you diversify.
Lewis: Yeah, I don't think anyone's going to stop buying stuff online and instead go brick-and-mortar, I don't think things are going to go off the cloud. I think, once we realized that the cloud is pretty great, we're going to stay there.
Lewis: [laughs] Alright. We have a second question; we're going to hit that in a second. Listeners, I just want to give you a quick reminder, if you want some stock ideas and recommendations, you can go over to our Stock Advisor service, get stock recommendations from David and Tom Gardner every single month, you get the Best Buys Now and more. You can get all that over at IF.Fool.com, and we have a special 50% off discount for our listeners over at IF.Fool.com.
Alright, Ben, our second question comes from Luiz. Luiz writes in, "Hey, Fools. One of my favorite podcasts around." Love getting a little listener love. "Truly appreciate what you do. I'm a Stock Advisor and Rule Breakers member, and I'm writing in with a question. I have stocks and ETFs scattered through multiple accounts. I have Robinhood, Stash, Acorn, Fidelity for my 401(k) and a Roth IRA with TD Ameritrade, as well as a small options account with TD Ameritrade. Do you guys think I have too many accounts or should I try to narrow it down." Luiz goes in through some of the logic why he has all these different accounts; mostly due to features. And then also writes, "Right now, I'm trying to do some work on position sizing. I feel like I'm overweight on some stocks, it's a little difficult to manage, particularly because I have too many accounts. Any suggestions on position sizing and the right number of accounts would be greatly appreciated. Again, thanks for your time."
So, there's a lot going on there with Luiz's finances.
Ra: Yeah, I mean, when it comes to the accounts, that's really up to what Luiz is comfortable with. I mean, I have three accounts and I'm comfortable with that. I hate memorizing passwords and writing them down somewhere. And I don't think I could handle more than three. I have one account for my 401(k), one for my Roth IRA and then another one for international trading. And that's enough for me. So, it's really what you're comfortable with. And I think simplicity is important for me. I don't know about you, I mean, I don't know how many you can handle, but for me, three is a lot.
Lewis: So, I'm very similar. I have the 401(k) provider we have through The Fool. I have assets with Vanguard and then I have my brokerage account with Merrill. And it's nice and simple, I know where everything is. The concern I have -- I can understand how someone winds up in a couple of different brokerages. You know, someone has a great robo-advisor service, someone else has that roundup that automatically puts money into an investing account for you, someone else has commission free trades, someone else gives you great options. And so, you know, very quickly it can multiply for trying to do all these different things. When you're just starting out, you're trying to do it cheaply.
What I would caution, though, is if you have a lot of accounts, when it comes tax time, you might miss something. And so, one of the benefits of only having a couple of accounts is that it's a little bit easier to make sure that you're checking all the boxes when you're leading up to April 15th and you need to make sure you're paying the amount you're supposed to be paying.
Ra: I agree with that. I mean, simplicity is very important for me. So, as I said, I can't handle more than three, but the more important question, of course, is the one on position sizing, and allocation is, first of all, extremely important. I mean, we always talk about stock picking and our company is really focused on stock picking, but when it comes to investment performance over the long-term, it's really two elements; it's stock picking plus allocation. And the second part really doesn't get as much play as the first part, but it's just as important.
Lewis: Yeah, it's not as much fun to be, like, this is how much you should buy, but only a little bit, it's much more fun to tell a great story about a stock.
Ra: Yeah. And it is super-important. I mean, just think about it, if you have a stock that returns, say, a 100% over the next year. If you just invest 1% of your portfolio in that stock, that's just a 1% return, if you invest 50%, that's 50% return. So, it can have a huge effect on your returns over the long-term. And unlike stock picking, there isn't a lot of, like, academic research on allocation, there is some, but there's not as much. I mean, with stock picking you have, you know, discounted cash flow, you have economic value, all of these academic studies that have been done over many, many years to support our thinking.
With allocation, it's much more an art than a science. I mean, there is the Kelly formula, which we actually kind of use, in Global Partners we kind of use it a little bit as a thinking aid. It's not the ultimate authority, but it is quite useful. As long as you fashion it for stocks and you have to juggle with the numbers, but it can help. And so, if you want to google that, you can take a look at it. I don't know the formula off-hand.
Lewis: [laughs] Could you give a quick, like, 60 seconds on vaguely how you'd use it? So, we don't have to get into specifics of the formula.
Ra: Yeah. So, the formula was developed for gambling games. So, it was developed for something like blackjack. So, based on what you think the downside is, the probability of that downside, based on what you think the upside is, and the probability of that upside, it'll give you an allocation; say, 20%, say, 30%. It tells you -- it tells, for example, a blackjack player to bet, say, 50% of your bankroll on a certain hand based on all of those variables. Now, the thing about the Kelly formula is that it gives you super high numbers. A lot of times it'll give you, like, 140%. So, you should take on leverage to buy the stocks. Is that something you should do? Probably not.
So, the one way you can do it is, you know, you can apply it to your portfolio based on what you think the downside is, the probability of the downside, etc., and then, sort of, average it out. So, if you have, say, three stocks and each of the numbers come out as 100%, then you could put in 33.333%, a third of your portfolio, into each stock. So, you could, sort of, like, average it and allocate it that way.
And I found, in my personal experience, that if you do that to your portfolio, it actually turns out to be pretty close to what you think about your stocks in the first place. So, it's not the ultimate authority, but it's something that could help your thinking and sort of clarify where you are, what you actually think about these stocks?
Lewis: Yeah. So, that requires going through the exercise of trying to understand upside and also trying to understand downside, which can be very helpful, probably a little bit more involved than some folks might want to get, especially folks that are just starting out.
Ra: Absolutely. And generally speaking, I think you should definitely start with the downside. So, know what you're risking with the stock. And if you have, say, a position -- and this is something, sort of, a thought exercise that I've presented to a lot of people -- if you have a stock that could, say, go up by 10X and the probability of going up by 10X is 90%, how much should you allocate to it? If the downside is a 100%; if when you lose that 10%, you're going to lose everything, how much should you allocate?
And there's no scientific answer for that, it really depends on what your situation is, if you're a student, if you just got out of college and you have, like, $5,000 in your bank account, then it's not wrong to put in all of that money on that bet and just make it $50,000; 90% chance is a pretty good bet. If you're 60 years old and you're facing down retirement, then it's a very different story. So, you have to know exactly what you're comfortable losing when you buy any kind of financial assets.
So, our general rule is to diversify. But I think over the long term what happens, say, you buy 20 stocks, what happens to that portfolio over the long-term is that it gets much more heavily allocated toward one, two stocks which are the big winners. And then the other 18 might be losers, and you could still do very well if that's the case as long as those winners will make up for the losers.
Lewis: Ben, it's like you were looking over my shoulder. When I was checking my brokerage account earlier. I own about 20 stocks in my brokerage account and I looked at the weighting, just to kind of have a good sense before I came in and talked about this. And I have three stocks that are slightly more than 10% of my portfolio each. And the reason for that is there are three stocks that have absolutely crushed it. It's Axon, it's MercadoLibre and it's Apple, so three companies that have done very well.
And I'm comfortable with that just about 10% allocation of those companies, because they've done really well, they've earned it and I like their prospects going forward. Now, I have 20 stocks, that means that the other 17 are splitting up 70%. And there are some that have a very small allocation, because they haven't earned that allocation.
The thing I come back to when I look at it, and say, "Wow! 10% tied to one thing" is, well my brokerage account is just one piece of the financial puzzle. So, I mentioned before, the 401(k), I mentioned the IRAs with Vanguard, those also play a factor. So, make sure you're, kind of, taking your entire financial life into the picture when you're starting to think about these allocations, because if you have 10% for one stock in a brokerage account, it's not a huge deal if that brokerage account is only 25% of your overall net worth.
Ra: Right. I mean, there's your house, if you own a house, there's your paycheck, so all of those things you should definitely take into account. But, I mean, what you said is very important there. And allocation is not just about how much of a stock I should buy, it's also a question that when the stock goes up, what should I do? If I have a 10%, 20% allocation in my portfolio then should I sell it, should I shave off a little bit of this position because it's too big or should I just let it ride?
And hopefully, when you get to that position of having a large allocation, you know more, you're more confident in the future of that stock. And that's really the test is, at that point in time, three, four, five years later, when your stock has gone up and you have this big winner, do you know more about the future of the stock, are you more confident in the future of the stock then you were three, four, five years ago. And hopefully, that answer is yes. If that answer is yes then, you really should let it ride in most instances.
Lewis: One of the simplest tests I've heard for this is, if it's keeping you up at night, it's probably too big. And so, you know, if that's the case, if you're really worried because you have one stock that has grown to the point where it's 25% of your portfolio, and that's freaking you out a little bit, it's OK to trim that position down. I think with position sizing, and also with the earlier part of this question about what's the right number of accounts, just make sure you're not doing anything that creates a taxable event that you're not ready for.
And so, if you are looking to consolidate down into one account or a couple of accounts, just don't sell just to do that, make sure you're understanding all the tax implications for the stuff that you're doing. And similarly, sell because the thesis is changing for you or because it's a little bit more than you want and you have something else you want to buy, don't just sell blankly, because you're going to probably pay some taxes on that.
Ra: Yeah, absolutely, yeah.
Lewis: Well, I mean, I think we covered that question. [laughs] We covered it really well. Ben, so awesome to have you on. It's always great to chat with you.
Lewis: You always take things in a place that I'm not quite expecting you to. And I always love the discussion. Listeners, that's going to do it for this episode of Industry Focus. If you have any questions, like I said before, reach out IndustryFocus@Fool.com or you can tweet us @MFIndustryFocus. If you want more stuff, subscribe on iTunes or wherever you get your podcasts.
And as always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass. For Ben Ra, I'm Dylan Lewis, thanks for listening and Fool on!