Is e-commerce a bubble?

Investing in e-commerce companies has become a leap of faith. Their valuations do not hold up to standard valuation methods. For example, Amazon has a P/E ratio of 97, which means we are paying in advance for profits spanning more years than the average lifespan of a Spaniard.

Under normal circumstances, this valuation would be a clear example of a bubble. But does that mean we should say that Amazon is a bubble and that sooner or later it will burst? Is e-commerce inflating the market?

Experts say that the most potent ‘drug’ in the world is not heroin or any other opiate derivative, but rather adrenaline, followed by dopamine. Neither of these are drugs; both are hormones produced naturally by our bodies in response to certain situations or stimuli.

Dopamine, or the ‘happiness hormone’, is released by our bodies at various times, including when we go shopping. For humans, shopping brings a sense of well-being.

Large retailers realised the significance of this trend some time ago and adapted their stores to meet customers’ need for wellbeing, but Amazon has managed to strip away the superfluous elements from the shopping process and focus its efforts on the act of shopping itself.

They have managed to ensure that someone suffering from insomnia can log on to Amazon at four in the morning from their bed and make a purchase, and that, as a result, they can sleep for a little longer. They have managed to become the anti-anxiety remedy that can be taken at any time or in any place, without causing any harm to the body.

But the curious thing is that we’re not just giving Amazon money; we’re giving it something far more important in the long run – which is actually what justifies that 97 P/E ratio. We’re giving it detailed personal information about our habits and behaviour. And we don’t really know how much information we’re giving it.

Amazon has been collecting a vast amount of data – known as ‘Big Data’ – for years.

No one in the consumer sector has as much information, or of such high quality, as they do.

For more than 20 years, until the end of 2010, Wal-Mart was the fifth most valuable company in the world. During those years, Amazon was nowhere near the top of the rankings. Just eight years later, Amazon ranks between first and third in the global rankings, whilst Walmart, the world’s largest retail chain, no longer features amongst the 15 most valuable companies in the world. And its value is less than 40 per cent of Amazon’s.

And the bad news for traditional retail is that this situation is only going to get worse. Amazon’s Big Data cannot be bought; it can only be built up over time. What Amazon has achieved is something that Walmart can no longer achieve.

Other companies, such as Inditex, have certainly done their bit – and how!

They have created a system for design, manufacturing, sales and distribution that does not clash with e-commerce, whilst also securing the Big Data that others have failed to obtain.

Today, it has the most advanced distribution and logistics system on the planet, in which radio-frequency identification of its garments is fully integrated into its internal control system. Previously, it took a whole morning’s work to take stock of a shop; now it takes just 5 seconds. They are now able to identify a customer’s shopping habits the moment they enter the shop, simply because they have the app installed on their mobile phone.

Stock optimisation creates the psychological effect of the ‘last item’ in the consumer’s mind, encouraging impulse buying and the resulting sense of well-being triggered by the release of dopamine.

A few years ago, Inditex commissioned MIT to develop a distribution algorithm for scarce stock items, based on the model and size for each shop. This means that distribution priorities are not determined by the time the internal order is placed, but by the likelihood of a sale.

Big Data provides Inditex with accurate information on consumer habits by shop, day, time, … And this is not something just anyone can access, no matter how much money they invest.

The consultancy firm Barin & Company has predicted that by 2025, 75 per cent of purchases will still be made in-store, but 70 per cent of these will be prompted by something that happened online.

In the 1970s, Spain had a subsistence economy. More than 40 per cent of disposable income was spent on basic foodstuffs. Thanks to globalisation, the average Spaniard now spends just 11 per cent on food, which leaves them with 27 per cent more of their disposable income to spend on other things – not just in their pockets, but also in their minds.

Whoever gets into the consumer’s mind first will come out on top.

And who is able to reach someone at four in the morning, when they’re lying awake? Well, anyone who is well positioned on the device that has been used most frequently on a daily basis in the history of humankind: the mobile phone. But that won’t be enough; the winner will be whoever knows exactly what to offer, but at that specific time and place.

Let’s consider that physical money is gradually disappearing. Cash is a problem for everyone – for consumers and businesses alike – because it gets lost or stolen;

for governments, because it gives rise to illicit activities; and for banks, because they spend a great deal of time and money collecting, counting and cleaning it. Let us not forget that countries spend 1 per cent of their GDP on maintaining cash.

Japan is the developed country with the highest proportion of in-person commercial transactions paid for in cash. Increasing the number of transactions is the first step towards boosting an economy – particularly one like Japan’s – which is very difficult if the majority of these transactions are carried out in cash. And the Japanese authorities are failing to reverse this trend.

Well, a simple app does the trick, because apps don’t let you pay with cash.

And who stands to benefit alongside e-commerce companies? Well, logistics companies. After all, I can buy a tennis racket in a shop or online, but to play tennis – or at least the sort of tennis Rafa Nadal plays – you need the actual racket in your hands. UPS, FedEx, Japan Railways and DHL will see similar growth.

Amazon has made a huge impact – and what an impact it is – on the daily shopping for food and everyday essentials. Once again, Amazon isn’t just making money; it’s also collecting data.

Amazon is introducing a cutting-edge innovation: unstaffed shopping. In other words, a supermarket without checkouts. And here’s an interesting fact: they’ve found that the rise in shoplifting is offset by the increase in sales resulting from the faster shopping experience.

So, going back to the first question: is there a bubble at a P/E ratio of 97, or do we need to change the valuation model?

Chief Investment Officer at Orfeo Capital SGIIC