Amazon: Continued Growth and High RBP Probability

Amazon.Com (AMZN) continues to dominate the online retail space and much of retail in general. Most importantly, its stock price implies a level of business performance that should be easy for the company to produce. (See AMZN’s RBP Snapshot as of October 7)

The company’s experience over the last year has been quite remarkable. Despite the stock losing 50% of its market value during the market collapse, the company continued to post strong results throughout. For the fiscal year that ended in December of 2008, the company posted sales growth of 29% over fiscal 2007. And for the twelve months ending in June of 2009, despite a recession and credit market freeze, the company was still able to report sales growth of nearly 20% over the same period a year earlier. Margins have continued to improve during this growth as well, resulting in operating profit, net income and EPS growth even higher than the growth in sales.

Amazon’s stock’s decline was a market effect, but was accentuated by fears that online spending would be curtailed along with consumer spending in general. Those fears proved to be inflated, as consumers instead focused on the type of values that Amazon provides. Now, with the uncertainty about the direction of sales resolved, the stock price has been corrected and the company is stronger than ever. At $93.36 per share, the company’s Required Business Performance implies sales growth of 12.6% in the upcoming year. Because of Amazon’s historical ability to produce sales well beyond this level, the company’s RBP Probability is a noteworthy 88.9%. This means there is an 88.9% probability the company will produce the necessary 12.6% sales growth.

The business model that Amazon uses is ideal for rapid growth. It has relatively low requirements for capital investment due to the absence of brick-and-mortar stores and has perfected a very efficient inventory management system. This means that it can ramp up sales without being restricted by the need for new capital or the operational capacity of its existing facilities. Indeed, capital expenditures have averaged less than 20% of operating cash flow since 2002.

The company has no meaningful debt and has been able to achieve all of its recent growth with internally generated capital—a testament to its superior profitability and ability to create value. Moreover, its entry into international markets gives it the resources to continue to grow at the remarkable rates that it has in the U.S. over its short lifetime. Said differently, company sales are unlikely to stall even if the U.S. market becomes increasingly saturated.

Unfortunately Amazon’s stock price has more than doubled from its March lows, but investors should not be blinded by the glowing opportunity in their rear-view mirrors. Amazon still represents a compelling buy and an opportunity to participate in the continually growing domestic and international online retail markets. The company will release its third quarter results on October 22. While it should exceed its required 12.6% sales growth at this time, I am more confident that it will meet its current Required Business Performance over the long-term.