For many years I have been looking for the investor’s philosopher’s stone. What’s the way to achieve the highest possible expected returns, and with not much volatility if possible? Long term value investing? Real estate? Selling volatility? Just investing in stock market index funds? Cornering the Alpha Black Lotus market? Hiring some expert dart throwing monkeys to determine my asset allocation?
Small FBA Businesses as the Way To Go
Well, in 2018 we found something better, and that’s what we have been doing since then. Small FBA Businesses (worth between $50,000 and $1,000,000) are sold for between 24 and 30 times their average monthly Seller’s Discretionary Earnings. That’s what a business makes before salaries. So, for example, a business making $10,000 SDE a month can be bought for around $280,000. On top of that you have to pay for the initial inventory. How much this is depends on the business, but it tends to be around 6 times its SDE, so that would be $60,000 more for a total of $340,000.
You may be thinking: “Cool story, bro, but out of those $10,000, how many end up in my pocket?” That’s going to depend on how efficient you are at running that business (and also on your tax situation).
The problems of running a fba Business
Running a FBA business may sound easy at first. It seems like you just have to keep ordering stuff from your supplier (the previous owner will tell you who their suppliers are) and money will magically flow into your coffers.
Well, it’s not that easy. This is a retail business after all, so you have to take care of many things to make it work. The only part that is easy is the fulfillment one. When someone orders your product, Amazon prepares the package and sends it to the buyer. But you have to take care of everything else.
Among many other things, you have to know how to price your product, you have to know how to make your listing attractive and descriptive enough that people end up buying your item, you have to answer in a effective way your customer’s questions and complaints, you have to know how to look for more suppliers and how to do quality control before it reaches Amazon, you have to know how to estimate how many units of each item will be sold to know when to order more and when, you have to know how much to spend in Amazon publicity (“pay per click”), which keywords to “target” and how, and a very long etcetera…
That’s a lot of work. That’s why this can’t be done by amateurs, running a FBA business properly isn’t learnt fast. And it requires so many different skills that you are going to need several other people helping you.
How We Run FBA Businesses Profitably
So the way to invest in that kind of asset is by building that needed team of competent people. That’s going to be so expensive in most places that it becomes viable only if you are willing to invest a lot of money. In Alpha Rock, however, we are achieving that in a quite efficient way. We run this business from the Philippines, which allows us to access talent at competitive rates.
The more businesses we have, the lower will our expenses be in relation to the SDE we generate, as the marginal cost of running extra businesses is quite low.
Also, as the businesses we buy are generally owned by individuals, they often fail in several of the things I mentioned before that are needed to run a retail business optimally. The most typical mistake is running out of stock of products, because of not properly planning when to order or having cash flow issues that don’t make it possible. Therefore, after we buy that hypothetical $10,000 SDE business, it’s realistic to increase that number by at least 10% shortly after acquiring it.
Taking Expenses Into Consideration
And then, how much of that SDE is gone in expenses? As of now, we estimate our expenses at around 50%, as we don’t just spend money in running the FBA businesses themselves but also in other things like raising capital. As time goes on, we expect expenses to drop until around 25%.
So, once we reach that 25% expenses goal, we’d be paying $340,000 for something that makes every month $8,250 ($11,000 minus $2,750). We are located in the US, so we pay 21% corporate tax (in practice it’s a bit less as businesses goodwill can be amortized). There are then around $6,500 left a month. That’s a monthly return of 1.91% (25.51% annualized).
How the Annualized Return of FBAs Compares
That’s without considering that Amazon is likely to keep growing, in the US and in other countries, and that we keep on improving businesses after acquiring them, so an annualized return of 30% is reasonable. Those returns are quite stable, there’s just some seasonality variance, which is predictable.
I don’t know of any other investment with expected returns even near that high. The stock market (understood as a globally diversified portfolio of stock indices) has historically achieved an annual return of 5.2%. Real estate has lower returns unless managed very efficiently (now instruments like REITS make that easier). Precious metals have around 0% historical real return. Government bonds, just 2%.
And all of those investments are quite volatile.
Moving Forward in the FBA Business World
Yes, there are some risks. Like in everything in life. Amazon could suddenly stop allowing other people to sell on their platform. This doesn’t make any financial sense for them. Around 50% of sales are done by third-party sellers, and that percentage has kept on increasing since Amazon consisted of just Bezos selling books. Amazon closing is possible too, but I think the likelihood of that happening is negligible.
All in all, I’m quite happy with what we found. If you may be interested in knowing more, just contact us. You can also get regular updates on Alpha Rock Capital and the FBA space by registering to our monthly newsletter, Antifragile.