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By Ahmed Ishtiaq

Amazon (NASDAQ:AMZN) had an interesting day, and the stock lost almost 6% in the normal trading hours. However, it jumped by almost 9% in the after-hours trading, due to an increase in margins reported by the company. Investors were probably concerned about the fourth quarter sales, and expected the company to report poor results. However, an increase in margins proved to be a positive surprise, and it excited the investors. An expansion in the margins was taken by investors as an indication of Amazon finally starting its ride on the path towards profitability.

The company has been promising a lot for a long time, but the profitability has often been sacrificed for a long-term relationship with customers. Furthermore, investment in new ventures on a regular basis has kept the company in the phase of evolution for a long time. As a result, a small increase in margins was enough to excite investors, which caused the increase in price in after-hours trading.

Fourth-Quarter Results

Fourth-quarter sales and net income for the company fell short of market expectations. The market was expecting the company to report revenue of $22.2 billion, and earnings of 27 cents per share. However, revenue and earnings for the fourth-quarter stood at $21.3 billion and 21 cents, respectively. Fourth-quarter sales went up by 22% compared to the last year. Net income went down by 45% for the company in the fourth quarter. However, operating income increased by 56% and gross margin went up to 24.1% from 20.7% a year ago. Expansion in gross margin was especially impressive for the company due to increase in sales and a slight decline in costs.

The growth in operating margin was driven by an increase in sales on its website by third parties. Third party sales made up 39% of units purchased, compared with 36% a year ago. Third party sales are an important component of earnings as the company charges a commission on items sold by an outside vendor, and that income is recorded as 100% profit. The company has over 2 million third party vendors at the moment. Operating income went up to $405 million, compared with an average estimate of $212.1 million. Furthermore, net income fell to $97 million or $0.21 per share, from $177 million, or $0.38 per share a year ago.

In terms of cost, spending on fulfillment is the biggest cost component for the company. Amazon spent $2.26 billion on fulfillment, an increase of 36% from the past year. Operating profit margins excluding taxes and investments is still extremely low for the company. However, there has been an increase in the adjusted operating profit margin, and it currently stands at 1.9%, up from 1.5% a year ago. On the other hand, shipping costs are coming down due to an investment in the warehouse expansion. Shipping costs stood at 4.5% for the company, down from 5.4% for the fourth-quarter last year.

Future Outlook

There are a few companies that can have an increase in stock price after a poor future outlook. Amazon, however, has been defying logic and investors have been buying the stock regardless of poor profitability. Amazon announced that first-quarter operating income will be between a loss of $285 million to a profit of $65 million. Revenues for the first quarter are expected to rise to $15 billion to $16.6 billion. As I have mentioned in my previous articles, the company is sacrificing short-term profits to gain long-term loyalty of customers. Recent results suggest that Amazon's strategy may be yielding dividends. However, there is a lack of loyalty in the business and customers will go to any other retailer who offers them the best price. As a result, the company will always have to be the best in terms of prices or it may lose market share. There is a low chance of it happening due to the immense size of Amazon; however, the risk remains.

Comparison with Peers:

Amazon peers include Best Buy Co Inc (NYSE:BBY), Barnes & Noble, Inc. (NYSE:BKS) and Apple Inc. (NASDAQ:AAPL). Amazon competes with Apple mainly in the tablets segment.

AMZN

AAPL

BKS

BBY

P/E

3333.3

10.00

N/A

N/A

P/B

16.60

3.20

1.10

1.50

P/S

2.20

2.50

0.10

0.10

EPS Growth

-2.80%

69.40%

N/A

N/A

Operating Margin

0.90%

33.50%

-0.40%

0.6%

Net Margin

0.10%

25.40%

-0.60%

-3.10%

ROE TTM

0.50%

38.40%

-5.90%

-34.00%

Debt to Equity

0.00

0.00

0.50

0.30

Source: Morningstar.com

Amazon has always been trading at a premium compared to its peers. However, the company has been able to give healthy return to its investors. The biggest concern for Amazon investors was a decline in margins. However, recent results indicate that the margins may start to climb in the future. As a result, Amazon investors may feel a little more confident than before.

Summary

Jeff Bezos has been able to successfully communicate his vision to investors on more than one occasion. As a result, investors have been buying into the company on the promise of a better future. Amazon investors have made substantial profits on their investments due to massive growth in the stock. However, the stock is still trading at insane multiples. Amazon stock will eventually revert to reasonable multiples, which means either earnings will have to go up substantially, or the price will have to come down. In the short-term, however, Amazon will carry on its rise and provide a good opportunity to make handsome returns.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: EFSinvestments is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Is Amazon Finally Starting Its Journey Towards Profitability?