Online retailer Amazon has thrown a shadow over the entire market and investors need to consider how other companies may be affected by its growing dominance, according to several fund managers.
The US online retail giant has been on an incredible run over the past five years and momentum has shown few signs of slowing down.
Most recently the company announced the £10.5bn acquisition of supermarket chain Whole Foods, giving it a bricks & mortar base in key locations across the US and UK.
With this development as well as improving organic growth and sales figures the share price has risen by 27.82 per cent year-to-date and is trading at near all-time highs.
Performance of stock YTD
Source: Google Finance
Lewis Grant, deputy manager of the Hermes Global Equity fund, said: “Everyone is talking about Amazon. Even other companies are talking about Amazon [because of the] positive or a negative effect it is having on their business.”
The company has had an impact on the Hermes fund as well, with the team having to re-assess how they analyse technology companies given the company’s long-term outperformance and strong share price.
“When assessing a company that is completely disruptive and changing its entire industry you have to throw out a lot of the ways of valuing a company that we have historically used,” he noted in an article last week.
Despite concerns over Amazon’s share price, which has continued to break through record highs, the managers have a 1.9 per cent weighting to the stock, an overweight versus the benchmark of 86 basis points.
“Yes, it has run but it has run because it is casting its shadow over the entire public equity market,” Grant said. “That is why for me these companies are worth the premium you are having to pay, because they are going to change everything.”
Geir Lode, lead manager of the Hermes fund, added that Amazon is rare in that it has an ’okay’ balance sheet, accelerating growth and is generating a lot of free cashflow.
“What I think has been a wakeup call for a lot of companies is that it is not enough these days to have the margin and the cashflow you also need higher growth to get these valuations,” he said.
However, when Amazon does begin to slow down, Lode he said it should be in good shape because of its growing cash pile.
“The day they stop the growth cash will be piling in because the expenses will be much lower,” he noted.
While buying Amazon outright is the most direct way for investors to gain exposure to its domineering presence in the market, the other is to invest in “the babies being thrown out with the bathwater,” according to JO Hambro’s Ben Leyland.
“When you get crisis moments in a sector or in a geography you tend to get the whole thing sold off because it is a basket trade mentality,” the manager said.
“We try and sift through the wreckage and be quite selective in identifying the specific businesses and management teams that we think can last through that period of weakness.
“’Amazon risk’ is one of those rare opportunities where you have got businesses with good barriers to entry and reasons to co-exist with Amazon being sold off just as much as other businesses which are going to be made extinct.”
While Amazon has been growing, companies and sectors that it is perceived to be in competition with have been declining rapidly.
The FE Alpha Manager, who manages the five crown-rated JOHCM Global Opportunities fund with deputy Robert Lancastle, is particularly bearish at the moment, but one area he is finding new ideas is in companies being undervalued through Amazon risk.
While he does not invest in Amazon due to its high valuation, he admits that it is a disruptive force in the market and companies need to innovate or face extinction.
Performance of stock over 5yrs
Source: Google Finance
However, Leyland argued that the company is not growing as ‘irrationally’ as some people think.
“I think there is a perception out there that Amazon shareholders don’t need profits and therefore Amazon can basically make a loss forever and their shareholders will be pleased,” he explained.
“So, they are willing to make a loss forever to kill everybody else’s industry – this is irrational behaviour.” 
“Amazon is very important but it is not irrational. Amazon seems to me much more selective and they are willing to invest very heavily in the near-term to make long-term gains.”
The company has been a dominant part of changing consumer’s behaviour who are now much more open to buying items online, meaning some retailers have had to adapt.
It has also been influential in promoting price transparency, with companies making ‘supernormal’ profits – where total revenue is greater than total costs – exposed by the tech giant.
“So, if you were making supernormal, unsustainable profits because the customer didn’t really know the gross margins you were making and there were no barriers to entry, then you are in a situation where Amazon is going to take down your gross margins to a more sustainable level,” Leyland noted.
“[However] if you have an industry or business with high barriers to entry and without supernormal profits then you can co-exist with Amazon,” he added.
“I don’t think it is plausible that Amazon will be the only retailer in 10 years’ time. I think it will be a dominant retailer but some companies will find ways to co-exist.”
He added: “They have to have the right infrastructure, the right pricing structure and the shares need to reflect that reality but it does not mean the whole sector is uninvestable.”
One area he is seeing this dispersion is in the US auto parts sector, which has been sold off heavily for fears that Amazon could try to take market share through the sale of car parts on its platform.
Leyland does not believe this is likely as the infrastructure required is too expensive and the sensible pricing in the market currently means there is not enough potential reward for the online retail giant.
“We particularly like the auto parts retailers in the US because the barriers to entry and the structure of that industry,” the manager said. “The majority of it is Amazon-proof and yet the shares are being treated the same as department stores.”
He argued that mechanics with a car on the ramp need parts within a short timeframe of as little as 45 minutes, whereas at the moment Amazon can only operate on a next day delivery basis.
“It is the logistical infrastructure that Amazon isn’t particularly interested in replicating. Amazon is interested in scalability and the infrastructure needed to dominate this market is not particularly scalable because it is not relevant for any other industries.”