Wall Street gets condemned constantly for being too short-term in its approach to companies and stocks, but if anyone in the financial markets wanted to make a counterargument to that criticism, they wouldn’t have to reach very far. All they would have to do is point to the example of Amazon.com (NASDAQ: AMZN), whose investors don’t seem to care all that much whether the company generates a profit, much less a growth in profitability.
Indeed, judged by traditional standards, the performance of Amazon’s share price almost looks absurd. Over the last 12 months, it has risen nearly 30 percent; year to date, it is up just north of 20 percent, beating the S&P 500 index by a full percentage point. Today, Amazon’s shares trade at nearly 16 times their book value, double the enterprise value (a more typical ratio is less than one), and its price/earnings ratio – even one calculated based on next year’s earnings – is so large as to be essentially meaningless.
And yet while the S&P 500, as a group, is generating at least modest growth in profits, earnings at Amazon have fallen off a cliff. The company’s most recent quarterly results caught analysts by surprise: While the consensus forecast called for $28.8 million (of profits, that is!), Amazon actually announced a $7 million net loss.
A net loss of that size when revenues jumped 22 percent to hit $15.7 billion might sound like no big deal. But it isn’t just the raw numbers that perplex some of those who keep an eye on the stock. It is the fact that Amazon seems to be consciously driving down short-term profitability and allowing margins to contract in hopes of generating higher long-term earnings.
The company’s spending on technology, and on the acquisition of content that it can then deliver via streaming to its customers, soared to $1.59 billion for the period – up nearly 50 percent, a far greater rate than the gain in revenue the company reported. And Amazon is hiring, on a fairly large scale. It announced a few days ago, just before President Obama toured one of the company’s facilities in Tennessee, that it plans to add more than 5,000 full-time “associates” at its warehouses.
Even as it spends heavily in quest of growth, Amazon appears willing to take a beating on its profit margins to maintain or expand its market share. It seems to be winning the tussle with publishing houses over e-book pricing (at least for now), and most recently has quietly slashed the prices on bestselling hardcover books, in an apparent bid to prevent Overstock.com (NASDAQ: OSTK) from eroding its market share. When Overstock announced a “We wrote the book on savings” promotion, offering 10 percent off Amazon’s prices on such tomes as Dan Brown’s Inferno, Amazon retaliated promptly, cutting the price on the novel to only $11.65. (The list price? A whopping $29.95.) As of today, Overstock’s price stands at $9.38, while Amazon is charging $12.38. Neither price leaves any profit on the table for the two companies.
The bottom line for investors: Amazon’s value today depends on trust – trust that CEO Jeff Bezos’s strategy of trading away short-term returns for a long-term upside will eventually pay off.
The idea certainly has its supporters. They argue that the company’s sale of Kindle e-readers and tablets will continue to generate content purchases, and that its massive investment in warehouses will result in more than just instant gratification when it comes to ordering kitty litter and barbecues for the backyard – that the spending may enable Amazon to venture further into the big grocery home-delivery market.
So maybe the old rules just don’t apply any longer, and we need to find other valuation metrics to use. But if so, which one?
One possibility is some kind of measure of cash flow per share. While the stock currently trades at the almost bizarre level of 220 or so times next year’s projected earnings, it’s now trading at 1.8 times sales and less than 30 times operating cash flow per share. That’s still lofty – Wal-Mart (NYSE: WMT) trades at only 0.5 times sales – but then it remains a much stronger growth play than other retailers. Others suggest that focusing on gross profits gives a more accurate picture of how Amazon is faring; they note that growth here was 34 percent in the just-reported quarter. At least that exceeds the 23 percent growth in operating expenses, which the 22 percent jump in revenue failed to do.
Even those who are skeptical about Amazon’s stock and the prospects of profiting from its long-term scenario should, however, draw comfort from the fact that Bezos has been very forthright about his intention to put the priority on long-term value creation rather than profits. On the other hand, the Amazon bulls may want to pause and contemplate not just the absolute levels or profits, losses, revenue and other metrics, but the fact that the company continues to report negative surprises.
If we are being asked to trust in a company’s long-term vision, the fact that it can still deliver a fairly significant short-term surprise isn’t all that encouraging.