You Can Get Anything You Want from Amazon…Except Profits
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The Fiscal Times
January 30, 2013

If you’re thinking about jumping on board the Amazon bandwagon in the wake of the company’s fourth-quarter earnings report and subsequent stock price surge, here is what you need to do: Put down the telephone or your tablet computer; back away from your computer. Do not follow through on that impulse.

It doesn’t matter how much you love your Kindle Fire, or that your letter carrier grumbles at the number of deliveries you get from Amazonia – dog food, DVDs, blenders or lingerie. Clearly, Amazon (NASDAQ: AMZN) is great at speedily delivering all the stuff that customers everywhere from Alaska to Key West want. That’s why its net sales jumped 22 percent in the fourth quarter to hit $21.27 billion, as you, I and many of those we know used Amazon to order our holiday gifts.

But even as Amazon’s sales soar, its profit margins are still so scanty that they are on the verge of disappearing altogether. Gross margins rose to 24.1 percent, from 20.7 percent a year ago. Operating margins edged up from 1.5 percent to 1.9 percent, as once again, the company’s expansion costs ate up a sizeable chunk of its sales.

Amazon’s operating margins compare unfavorably to those of Walmart (NYSE: WMT). Scary? Well, it gets worse. Walmart wants to increase its margins. Jeff Bezos, Amazon’s founder and still its CEO, seems to view any questions about ramping up profitability with a great deal of nonchalance, attributing it to his company’s business model being misunderstood. And he has added that he’s OK if that misunderstanding lasts for a while.

At least, so far, investors aren’t paying the price for this attitude. In part because some parts of the results weren’t as bad as expected, enough investors have jumped in to buy the stock. Clearly, at least some of the rally could be traced to short-covering, as traders who bet that a gruesome earnings release would provoke a selloff scrambled to cover those bearish positions.

Those modest margin improvements were reason for optimism among some analysts. "We can't help but stop and wonder whether the Amazon bull case has now pivoted from one of revenue growth to one of margin expansion," Barclays Capital analysts said in a note, according to Reuters.

Amid the euphoria, let’s not forget, though, that Amazon’s fourth-quarter profit plunged 45 percent to $97 million, or 21 cents a share. That compares to 38 cents in the year-earlier fourth quarter, and is below the consensus earnings expectations of 28 cents a share.

So, if profitability and better margins are on the back burner for now, what is Bezos’s big dream? He is intent on his company being a one-stop consumer wish-fulfillment shop.

Want to watch a movie, or an episode from that hit show? Here it is on Amazon’s instant streaming. Oh, and if you sign up for Amazon Prime for $79 per household, you get that for free, along with two-day UPS shipping on most items that you buy from Amazon’s own vast fulfillment centers. And how many people willing to fork over $79 are not going to recoup that cost over the course of a year?

Want to read an e-book? Well, there are hundreds of thousands of them available via Amazon for your Kindle, or just to read on your computer, at prices from a few pennies to $15 or more. Bezos seems convinced that if you build it, we will come, and so he has sunk massive amounts of capital into developing new infrastructure, ranging from warehouses to the latest array of Kindle devices, which you can acquire for about half of what you would pay for a comparable iPad. Bezos is betting that once you have the device, you’ll pay up for content to go on it.

That may be true. Indeed, in the long run, Bezos’s analysis may be completely accurate. But it remains to be seen just how long the long run proves to be, and when these elusive hefty profits might materialize. So far, there is little evidence, beyond logic and supposition, that these will materialize.

A company’s success isn’t measured by its revenues, but by its ability to deliver value to its investors in the shape of profits. That’s why the P/E ratio, or price/earnings ratio is the key metric that investors study. Amazon – brace yourself – now trades at 3,099 times its earnings over the last 12 months. The S&P trades at around 14 times trailing earnings.

Now, it’s true that we’ll often invest in companies that have astronomical valuations and relatively little to show in the way of profits, but usually that is because they can demonstrate a clear path to greater profits within the forseeable future. In Amazon’s case, however, the picture is murkier. As sales have risen, its profits have declined. This isn’t a case of a few quarters, but a trend that has taken shape and become more dramatic over the last year or two.

There are more headwinds to worry about, too, such as the potential impact of having to collect sales taxes from shoppers in places like California, Texas and Pennsylvania that had previously let online sales go tax free.

By all means, continue to take advantage of Amazon’s largesse as a consumer. But buying its shares at this price, pretty much guarantees months more of anxiety. The stock may rally still further – but based on what fundamental improvement?

Sadly, without a crystal ball it’s impossible to tell just what will suddenly come along to make investors realize that – heavens! – the emperor’s new clothes just aren’t there and he’s strolling down the street naked. But the odds are high that at some point there will be a sudden loss of confidence, just like the one that has battered Apple (NASDAQ: AAPL) in recent months. Odds are there will be opportunities to pick up Amazon’s shares far more cheaply in the future, closer to the time we begin to see real signs that Bezos’s massive investments are paying off. For now, however, investing is a high-risk act of faith.

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.