Exponential Growth
Obvious Investments - Really?
Would you invest in a company which is growing at 4-year CAGR of 100% p.a.? Obviously, Yes! However, Jeff Bezos thinks otherwise!
In one of the letters to shareholders, Jeff Bezos lays down why Investing in Blue Origin, the company which took him and a few others on a space trip is bad investment financially. The letter from Jeff distils how earnings growth rate of 100% YoY for 4 years and cumulative earnings of USD 150 mln. while investing in Blue Origin, is not really a good investment financially.
Imagine that an entrepreneur invents a machine that can quickly transport people from one location to another. The machine is expensive - $160 million with an annual capacity of 100,000 passenger trips and a four-year useful life. Each trip sells for $1,000 and requires $450 in cost of goods for energy and materials and $50 in labour and other costs.
Continue to imagine that business is booming, with 100,000 trips in Year 1, completely and perfectly utilizing the capacity of one machine. This leads to earnings of $10 million after deducting operating expenses including depreciation - a 10% net margin.
Based on initial results, the entrepreneur decides to invest more capital to fuel sales and earnings growth, adding additional machines in Years 2 through 4.
Considering that there is 100% Earnings Growth YoY and Cumulative Earnings is USD 150 mln., Blue Origin would continue to incur gobble cash!! Yes, negative USD 530 mln. in 4 years.
Earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings. Future earnings are a component - but not the only important component - of future cash flow per share. Working capital and capital expenditures are also important, as is future share dilution. - Jeff Bezos
Hope, investors take lesson from the above. Hope, massive growth potential-companies coming out with recent IPOs to lure investors could spell this out clearly! ‘Hope’ is the key word here!