Derius Hopkins
Purdue University Global
FI499 Bachelor’s Capstone in Finance
Dr. Ernesto Escobedo
5-28-23
Operating and financial leverage of Amazon
Operating leverage describes a company's capacity to make a bigger profit off of its fixed costs. Financial leverage, on the other hand, refers to a company's ability to seize opportunities given by its capital structure to increase earnings while at the same time lessening the amount of tax burden it must endure.
By having a cost structure that is dominated by fixed costs, operating leverage can be attained. The corporation has invested heavily in the construction of data centers geared toward cloud enterprises as well as distribution centers geared toward online retailers (Boco, 2022). The continuous costs associated with these investments are represented in the financial statements. The extent to which Amazon leverages its financial position by using its fixed-income securities and shares to finance initiatives may be measured by this. Investors frequently use the debt-to-equity ratio to determine how much additional debt a company, such as Amazon, is taking on to increase its leverage. This ratio evaluates the company's entire equity against its total outstanding debt.
Long-term investors have a fantastic investment opportunity due to the company's recent decrease in share price because of the company's outstanding future development prospects and competitive advantages, such as high barriers to entry. Investors' worries about the company's declining free cash flow resulted in a drop in share price for the shares. During the epidemic, it more than doubled its spending and increased the size of its networks. Next, it will endeavor to streamline the network it has invested in to further boost the operating leverage it enjoys. The use of a large amount of leverage is a common indicator of the financial risk that companies face.
Market risk is the "financial risk" that Amazon's investor's experience as a direct result of the company's increasing levels of debt. The significant debt-to-equity ratio suggests that the company has heavily relied on debt to finance its growth. This strategy carries a greater degree of possible risk. Another way to figure out how much of Amazon's assets are owned by shareholders as opposed to creditors is to calculate the debt-to-equity ratio. The same approach as before can be used to accomplish this. Amazon has more assets than its stockholders can claim as their own because it has less debt. A company is said to have a considerable amount of leverage when its creditors own more than 50% of its assets.
Effects of Correlation on the total risk of an investment portfolio
The strength of the association between the prices of individual stocks in a diversified portfolio is what's measured by correlation. An investment's correlation shows how its performance has changed from other investments' performance. Positively connected investments are more likely to gain in value concurrently, but negatively correlated investments are more likely to drop in value on their own. The potential danger that two assets pose to your investment portfolio increases with the degree of similarity between them.
It matters more than a new investment has a low average correlation with the rest of the portfolio than that it exhibits little deviation from the rest of the portfolio. Diversification, which entails the addition of assets that are not entirely favorably connected, can lower the standard deviation of the portfolio. The advantages of diversification increase when portfolio risk decreases and vice versa since there is a decreasing correlation between the returns of the assets in a diversified portfolio.
Positive associations, negative correlations, or even no correlation at all, are all possible. Positively connected investments are more likely to gain in value concurrently, but negatively correlated investments are more likely to drop in value on their own (Jayathilaka & Park, 2022). The two stocks have no relationship since there is no correlation between them. The potential danger that two assets pose to your investment portfolio increases with the degree of similarity between them. A portfolio's risk can be either enhanced by positive correlation or lessened by negative correlation because assets might move in a variety of directions. The fact that portfolio risk can be impacted both positively and negatively is what causes these two outcomes.
VAR for Amazon
It is possible to determine the potential risk that your financial holdings provide to you by using the value-at-risk method. It sees widespread application in the process of estimating potential losses on investments in the context of the present market conditions. Utilizing the Amazon Value-at-Risk Technical Analysis Lookup, you can examine this and other technical indicators relating to Amazon Inc. or any other stock.
This is the formula for the variance adjustment factor (VAR): VAR = ER(A) * N + (Zscore * STD * SQRT(N)) = 2.74
At this time, the Value At Risk for Amazon is negative $2.74. It is possible to estimate the financial risk connected to an investment instrument over a given period by using a statistical technique called Value At Risk (or VAR). It is a common statistic that is employed to assess the probability of suffering financial losses in connection with a certain investment vehicle.
Due to its competitive advantages and substantial head start, Amazon will be able to keep holding down the top spot in many markets for the foreseeable future. Amazon will be able to maintain its competitiveness thanks to these advantages (Dai et al., 2022). However, when growth is the main goal, it is impossible to avoid spending money on expansion. Recently, there has been anxiety in the market over its potential to create positive free cash flows. This is your chance to witness firsthand the company's well-earned reputation for successfully lowering its past costs to maximize its revenue in the future. As a result, I think that right now is a great opportunity for investors to start purchasing shares of the company's stock.
References
Boco, C. (2022). Capital structure and re-leveraging operations: a case study on Amazon's enterprise value. Retrieved from: https://tesi.luiss.it/id/eprint/33422
Dai, Z., Zhu, H., & Zhang, X. (2022). Dynamic spillover effects and portfolio strategies between crude oil, gold, and Chinese stock markets related to new energy vehicles. Energy Economics, 109, 105959.
Jayathilaka, U. R., & Park, G. C. (2022). The Impact of Amazon Global Selling on Innovation Performance of SMEs. Journal of Artificial Intelligence and Machine Learning in Management, 6(2), 1-13.