One Truth About Amazon (That You Probably Didn't Know)

| About:, Inc. (AMZN)

By: Jake Mann (NASDAQ:AMZN) has been generating Apple-level buzz over the past week, as the e-retailer reported its fourth quarter financials late last month (see our recap). While many investors have simply thrown up their hands in frustration at the stock's sky-high multiples, it's important to realize that Mr. Market is valuing Amazon for its massive online footprint and, more importantly, in the hope that its diversified revenue streams can eventually translate into superior earnings power.

For readers looking for a fresh take on how to beat the market, check this out, and for an equally fresh take on Amazon, continue reading below. See, we're not interested in contributing the same drivel about this stock that's thrown around the blogosphere daily. Headlines like "Amazon's Valuation Doesn't Make Sense" are rampant, and are frankly a waste of time. Chances are, you've probably read that story literally a million times before, so let's skip that part.

Instead, we're going to explore one "truth," so to speak, that should help investors gain a better understanding of Amazon's potential. Now, this isn't a list of reasons to buy or sell the stock, but it should at least teach you a new thing or two about the company. Without further ado, here it is:

Conversion rates aren't driving revenue growth, sheer size is.

Let that sink in for a second. We'll explain.

Put simply, a website's conversion rate measures its ability to monetize its users, whether this is in the form of a news site gathering paying subscribers, or an e-commerce site stimulating purchases. In Amazon's case, the percentage of visitors that buy its products varies depending on the season, but has been estimated by key personnel to be between 4% and 8%. Nielsen/NetRatings has released a few estimates irregularly that predict Amazon's conversion rate to be in the 9-10% range.

By comparison, peers like eBay (NASDAQ:EBAY) and Office Depot Inc (NYSE:ODP) are estimated to average conversion rates between 11% and 12%, but that's not the most important conclusion we can reach from this data.

See, a common bullish thesis of many Amazon investors is that the company is vastly improving its in-site conversion methods, whether its via "Frequently Bought Together" and "Customers Who Bought This Item Also Bought" suggestions, or through improved web functionality.

Judging by the fact that Amazon has grown its revenues by a stellar 35.6% average over the past three years, and Wall Street analysts are projecting top line growth in excess of 20% this year, we could assume that if web traffic was static, this thesis would remain intact. Interestingly, though, this hasn't been the case.

According to popular e-metric site Alexa, Amazon's daily reach is approximately 55% greater than it was just two short years ago. The company's online traffic rank, which rested in the high teens throughout much of 2011, has now risen to No. 8 (globally). Google Trends, which measures search volume, also indicates that Amazon's online presence is close to 50% higher than it was at this same time in 2011. Though both of these data providers measure the company's e-footprint in a slightly different way, it's encouraging that growth results are within a 5% margin.

While we can't drill down and compute exact conversion rates without hard data from Amazon, the simple trends discussed above - rising revenues and an even quicker rise in traffic - indicate that most likely, Amazon is growing its business by expanding its online traffic, not by boosting its conversion rate.

We're not inside Jeff Bezos' head, but if we were, we'd have to imagine that conversion rate improvement is a key goal for the e-retailer moving forward. Judging by Amazon's rosy outlook for its Prime service, it expects to take at least a few percentage points of the estimated 90-95% of online visitors that currently do not purchase a product. Moreover, the company's announcement of its Amazon Coins service gives it another way to tackle this group of inactive users.

While nothing is certain, it's crucial for investors to realize that Amazon's massive potential may best be described in this traffic-conversion rate relationship. With a greater visitor base - as noted by the traffic estimates presented above - to now work with, it's possible that Amazon can avoid a growth slowdown that many bears are fearful of by simply convincing more visitors to buy its products.

Due to the fact that some e-retailer peers like Proflowers and Coldwater Creek have conversion rates in excess of 13%, there's clearly potential for Amazon to improve in this arena. In turn, this would make any investor buying in the face of the average financial journalist's regurgitated "Amazon's P/E is too expensive" reasoning look rather smart over the long, long run.

Disclosure: I am long AAPL, GOOG.

Business relationship disclosure: This article is written by Insider Monkey's writer, Jake Mann, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.

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