It is increasingly difficult for investors to decide if they should keep Amazon (NASDAQ: AMZN) in their portfolio. On the one hand, Amazon has become synonymous with online retailing in the same way that Xerox and photocopying have become inextricably linked in the public consciousness. On the other hand, its fundamentals seem to be painting a contradictory picture of its actual financial condition. As an investor, should you take Amazon's seeming financial health at face value or should you start looking for another place to park your money?
A good place to start when considering Amazon's fundamentals is its recently released first-quarter earnings report. For the first quarter of 2013, the online retailer reported a net income of $82 million, which was 37% lower than the $130 million reported from the same quarter last year. Net sales, on the other hand, increased to $16 billion from $13.2 billion, the bulk of which came from product sales, with branded services taking in only $2.8 billion. It's worth noting, however, that the reason for the decline in profitability is not because the company is not doing well, but because it is spending heavily on creating new products. When viewed in this light, the increase in sales is the more significant metric. Net sales over the past five years have actually increased by 227% from 2009.
The more significant metric that Amazon wants to stress, however, is free cash flow, or the amount of money the company generates beyond what it spends to continue growth. This measure is considered one of the most important when considering how financially healthy a company is. But again, Amazon's big capital investments have affected this measure, as it only reported $177 million in free cash flow from $1.15 billion, an 85% decline. However, this decline was accounted for by the company's outlay for new office property of $1.4 billion. Unfortunately, free cash flow has also been declining over the past few years, after reaching a peak of $2.32 billion in 2010. And since revenues trail free cash flow, the company can also expect to see earnings decline if this trend continues. Net income growth has also been slowing down over the period, although it has consistently been growing. On the other hand, gross margins have been growing, indicating that Amazon is keeping an increasing share of its net sales, which it can use towards meeting and paying off its expenses. The company's gross margins have grown from 23.5% in Q1 2009 to 26.6% in the first quarter of 2013.
Despite the mixed messages delivered by these numbers, Amazon stock prices have continued to appreciate, growing some 237% from $78.48 on May 26, 2009 to $261.74 as of May 24, 2013. This means that investors who kept the faith with the company would have earned a handsome return on their investment.
Now that the fundamentals have been considered, what are the other reasons investors should remain confident in Amazon? The company's premium membership service, Amazon Prime, is proving to be a profit generator for the company, since it is estimated that Prime members spent as much as 150% more at the site once they became members. In addition, they started shopping at the site for items that they would normally get at offline outlets, since they could avail of free unlimited two-day shipping. It is estimated that at present there are some 10 million Prime members, and analysts believe there could be as many as 25 million members by 2017.
In addition, it has ventured into content generation in order to compete with video streaming services Netflix (NASDAQ: NFLX) and Hulu. Its Amazon Studios produced 14 pilots for potential series that it posted online, and will decide which ones will go to series based on feedback from viewers. Amazon is also moving to compete in the tablet computer market by expanding sales of its Kindle Fire to more than 170 countries and territories while rolling out its Appstore in over 200. Increased sales of the Kindle are also expected to boost use of Amazon services since the tablets are designed to function using the e-tailer's services.
Amazon is also set to become a dominant force in the cloud computing field with its Amazon Web Services, which offer a variety of remote computing services and is expected to generate some $3.8 billion in revenues in 2013.
The Bottom Line
Despite the numbers, if there is one company that is set to defy its fundamentals, it is Amazon. Apart from its pre-eminent position in the online retail market, it also enjoys the visionary leadership of CEO Jeff Bezos, whose cohesive vision for this company has successfully defied Wall Street's expectations. The company can only get stronger in the long term, and investors would do well to exercise patience and add Amazon stock to their portfolio, since they will surely be rewarded in the long run.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.