Over the past few days, I've seen quite a few articles trying to explain why Amazon (AMZN) saw its stock price increase following disappointing revenues and earnings when it announced its latest results. Some tried to compare it to Apple (AAPL). I don't think it makes much sense to compare those two technology giants. That being said, I'm planning on starting to accumulate a very long-term position in Amazon.
Difficult To Value
There is no doubt about it, trying to come up with a value for Amazon is a major challenge. Estimates vary quite a bit, but Bloomberg estimates that the company is trading at an incredible 737 times earnings. That might lead you to believe that revenues and earnings are exploding, but that's not exactly the case. In fact, earnings per share for 2012 decreased by nearly 50% to $1.37/share. Profit margins have shown signs of improvement, but it's nowhere near something that could justify such P/E ratios. As a fundamental investor who uses the P/E ratio, Amazon creates major challenges.
Just look at these 3 charts, and I doubt you'll be convinced the valuation makes a lot of sense.
(click to enlarge)
It's All About The Vision
I would argue that in one rare instance, it's not all about the profits. I know, we've heard that rationale before (dot com bubble) but in Amazon's case, it can be justified. I believe it's about seeing what Amazon can and will become rather than what it currently is.
Bigger, Better Wal-Mart
Wired magazine made an interesting comparison between Amazon and Wal-Mart (WMT) -- one that I've made in the past. The fact is that Wal-Mart took over its sector through a superior organization and in many ways, Amazon is the 21st century Wal-Mart. It is able to operate at much lower cost than companies such as Wal-Mart because it has so little retail space. Its big warehouses and shipping centers are usually outside of urban areas, and have been built to optimize quick and efficient shipping with the lowest possible cost.
Amazon started off selling books, and has basically killed national bookstores such as Barnes and Noble (BKS) by offering lower prices and a better service. That trend has continued as Amazon started going up the food-chain. Amazon has started publishing its own books -- a scary trend for publishing houses. Why? Among its advantages, Amazon is able to print on demand, something that ends up saving millions and making the entire operation much more efficient. It has also imposed its pricing structure on ebooks, as it controls over 90% of the ebooks sold online.
It's Not Just Books
If you've shopped on Amazon, you know that books were just the start. Major retailers such as Best Buy (BBY) are now in trouble because they simply cannot compete with Amazon's prices. The company is on the verge of going under, and has already announced it is closing 8 of its stores. There are countless other industries that fear Amazon as it continues to improve its offerings (free shipping for Prime members, same-day delivery in many cities, etc).
Believing In Jeff Bezos
We rarely hear about Amazon's strategy. Just take a look at most earnings transcripts and you will see that most analyst questions are not answered. Amazon breaks down very few of its numbers, and does not give many hints about its pricing, planning, etc. My theory is that Amazon has one priority -- working on 10 and 20 year goals -- and does not care about quarterly earnings or trying to see if making investment X or Y will end up causing an earnings miss. Jeff Bezos has a unique vision, and he has been following it for years. I believe that he is clearly doing things in very different ways, but those are being proven correct over and over.
One of the few indications that Jeff Bezos gave about pricing was when he discussed the Kindle pricing, when he explained that Amazon was not trying to make money by selling the actual device but rather, by having buyers consume the content through it. That has made Amazon's pricing extremely competitive. The company does seem to know which areas it's trying to win, and is able to sell for no profit (or even losses) for long periods of time in order to get it done. Very few companies even try to use longer-term strategies.
I think Amazon's expansion, both geographically and in its products, has been very smart as Amazon works hard on taking over a few products at a time. I could easily imagine that Amazon could end up delivering groceries or many other types of products, but that would only make sense once Amazon has a lot more fulfillment centers. In the same way, as much demand as there has been to expand its Prime service abroad, Amazon has been very patient in building its infrastructure and only opened its doors to Canadians a few weeks ago once it proved to be ready.
Unparalleled Customer Service
How many Amazon customers do you know? I would imagine quite a large number. How many of those have a bad experience to talk about? I would venture that the number is very small. Amazon's purchase of Zappos (the customer service specialist) a few years ago was just one example of how focused it has been on providing the best customer service.
Not A One-Trick Pony
I'm not a big fan of the concept that Google (GOOG) is a one-trick pony. But you'd have to admit that it's certainly possible to envision a world where Google's dominance could be threatened. In some ways, it already is. In the same way, finding scenarios where companies like Apple (AAPL) and Facebook (FB) start declining is not that difficult. Amazon is clearly a more sustainable company. I would challenge you to come up with a scenario where Amazon ended up being threatened or seeing declines. Which company could possibly compete with Amazon in the ecommerce sphere and how? Wal-Mart and others certainly try, but they are losing ground every day and are already very far behind.
Hoping All Revenues Are Reinvested
I would personally be happy to see Amazon stick to its current plan for several more years. Keep profits low by focusing on the lowest prices, the best customer service and expanding what is already an incredible infrastructure. That would continue to make it look impossible for competitors to catch up, and would keep the P/E ratio high enough to discourage many buyers (keeping the price lower for me to load up).
Amazon Does Remain A Gamble
I would not dare say that there is no risk involved here. Amazon lacks transparency, and we don't know what its plan is. What if Jeff Bezos wants to keep doing this for a few more decades and never truly puts focus on earnings? I doubt the stock price could sustain its growth if the margins continue to be very low. I also truly hate the idea of buying a company without being able to truly get a good feeling on its current valuation. Trying to do 10 or 20 year forecasts on revenues and margins seems like an impossible task, so it's certainly possible that all of what I'm describing is already priced into the stock.
There is also the possibility that Amazon could end up screwing up, or facing competition from newcomers that can build a superior policy. Google continues to compete in many ways with Amazon, and I would never take a company led by Larry Page lightly.
It Is Worth Taking?
I personally think that Amazon has incredible upside over long periods of time. It has already started changing the way we shop, and that is just getting started. The company is well-positioned in so many different product categories, and I do believe that margins will increase over time. There is certainly some upside, and it would be easy to look at the chart and think that it's too late to buy Amazon. I would argue that the rise is just getting started.