There's a very interesting discussion in a book called The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies, by Aswath Damodaran (2001).
The book's timing was somewhat unfortunate, as its opening line asked, "Do the old rules still apply?" and "Can you value a company that has no earnings, no history, and no comparable firms?" just as the dot-com bubble was imploding and many of the investors who had decided that the old rules did not still apply were watching their vaunted "new economy" collapse.
However, Professor Damodaran's book was no cheerleader for investing in companies with no business model -- far from it. The book actually asked some very important questions about the appropriate ways to value technology companies, advocated solid methodologies, and reached many valid conclusions. It is all too easy to criticize the book with the benefit of hindsight, as if it should have anticipated the dot-com collapse (when those critics probably did not either).
That said, we were flipping through our old copy of Professor Damodaran's book recently when we came across a paragraph which, with the benefit of hindsight, is almost knee-slappingly funny (as much, that is, as a discussion of valuation can be).
In a section on cash flow estimation, Professor Damodaran discusses whether an analyst should capitalize SG&A expenses for certain
tech companies (capitalizing an expense is appropriate when that expense is
anticipated to provide revenues over a future series of time periods – for
instance, a farmer might buy a tractor which is an expense all at once but
which will help him to gather harvests for several years, and thus he might
capitalize that expense over the expected number of future years that the
tractor will be providing him with benefits). He uses Amazon.com* for his example, and his discussion is useful for showing just how far Amazon has come:
We decided that selling, general, and administrative expenses should continue to be treated as operating expenses and not capitalized for Amazon for two reasons. First, retail customers are difficult to retain, especially online, and Amazon faces serious competition not only from Barnes&Noble.com and Borders.com but also from traditional retailers, like Wal-Mart, setting up their online operations. Consequently, the customers that Amazon might attract with its advertising or sales promotions are unlikely to stay for an extended period just because of the initial inducements. Second, as the company has become larger, its selling, general, and administrative expenses seem increasingly directed toward getting revenues in current periods rather than future periods. 115 - 116.
As stated above, it's not fair to sit in judgment with the benefit of hindsight and make fun of someone's analysis from twelve years ago (and we generally like his book and agree with most of it), but when we read that paragraph it's hard to tell if Professor Damodaran is talking about the same company that is known as Amazon today! Twelve years later, Amazon has crushed the competitors mentioned above (particularly Barnes & Noble and Borders, the latter of which filed for bankruptcy protection in 2011), and differentiated itself quite successfully from Wal-Mart*. But at the time those words were being written, Amazon had yet to turn a profit (it would not report a positive earnings quarter until the end of 2002).
Perhaps more important, however, is the discussion of the question of whether SG&A expenses are geared towards generating revenues in current periods or future periods. Professor Damodaran concluded that Amazon customers "are unlikely to stay for an extended period just because of the initial inducements" and that expenses are "increasingly directed toward generating revenues in current periods rather than future periods."
He could not have known at the time about Amazon Prime, which has almost completely reversed the situation as he describes it, and thus the fact that his conclusions appear today to be "180 degrees out" should be seen as more of a tribute to the business savvy of the leadership at Amazon than to any shortfall on Professor Damodaran's part.
Here is an article describing the significance of Amazon Prime (from February of this year). It notes that Prime was introduced in 2005, and membership has been growing at 20% per year, but still represents only 4% of the company's total customers. It also points out that Prime customers on average spend 130% more on Amazon than regular Amazon customers (we'd call that a refutation of the idea that customers on Amazon won't stay around for an extended period).
These are very significant statistics. Looking at Professor Damodaran's "blast from the past" helps to highlight the significance of the achievements of Amazon as a company since the year 2000, and the significance of Amazon Prime for the company's future.
* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by Amazon (AMZN) and did not own securities issued by Barnes & Noble or Wal-Mart (BKS or WMT).