For years, Amazon (NASDAQ:AMZN) stock was seen as "defying gravity." Value investors offended by Amazon's outrageous P/E would pull out a calculator at a drop of a dime willing to prove how Amazon's valuation also defied logic. Wall Street never cared. The stock kept making new highs as long as the revenue growth kept rising.
Amazon proved time and time again that it can deliver the goods - to your door and during each earnings announcement. But that appeared to have changed. Last week, the company delivered nothing but disappointment. And Wall Street has punished the stock ever since - to the tune of a 14% drop. And it doesn't appear as if the bleeding will stop any time soon.
But before we jump into the company's details, there were external factors that -- I believe -- adversely impacted Amazon. First and foremost, Amazon had the unfortunate timing of following a strong second-quarter report by Apple (NASDAQ:AAPL), during which Apple beat on every important metric, especially profits. Secondly, as the week began, hedge-fund manager David Einhorn spooked investors by suggesting that the market is experiencing its second tech-bubble in 15 years.
Einhorn's comments, in my opinion, reminded investors of how they erroneously ignored profitability in favor of "potential." To that end, while Amazon's absolute results didn't sway that drastically from what the company has produced in the past, they did reflect the degree to which CEO Jeff Bezos has focused on the company's persistent spending, while advocating weak margins. Wall Street, by its reaction, implied it has had enough.
Amazon posted roughly $20 billion in revenue, growing 23% year over year, enough to easily beat consensus estimates. Profits, on the other hand, was seen as weak. But as noted, in the past, that has never mattered. First quarter net income came in at $108 million, resulting in earnings of 23 cents per share, a penny above what analysts were predicting. Last year, the company posted earnings of $82 million, or 18 cents per share. And considering the 26% year-over-year increase in the company's operating cash flow, Amazon appears healthy.
The problem, though, analysts were spooked by Amazon's capital investments. The company put out roughly $17 billion for the quarter. All told, Amazon's operating margin, which were never impressive to begin with, were at a putrid 0.7%. And this is even with a 9% return on invested capital. So while Bezos continues to be a revenue growth machine, analysts have changed their tune and are now asking "where's the beef?"
And it certainly didn't help that Bezos spooked investors even more with weak guidance. Although the company projects revenue to grow in a range between 15% and 26% year over year, Bezos said Amazon will revert back to reporting a loss - one estimated to be between $455 million and $55 million. In last year's second quarter, Amazon posted a profit of $79 million. Almost immediately, analysts rushed to lower their price estimates, which spurred the stock's free fall.
Amazon continues to be an incredible growth story. And in Jeff Bezos, the company has one of the best CEO on the market. But the company can't put profitability on the back-burner forever and assume a now "skittish" market will ignore this indefinitely.
So what's an investor to do?
Those who have been long on the stock for more than five years have certainly done well. And a case can be made to sell today and move on to the next great idea. For others, I don't think Amazon is close to reaching bottom. I was bullish on the stock recently and suggested that it will reach $400. I clearly blew this call. This was on the assumption of sustained margin expansion and profits. With the company now projecting a loss, things have changed.
With the stock now trading at around $300 and the notable "Sell in May" strategy right around the corner, Amazon may not find support until it releases second-quarter results. To that end, I would recommend those on the sidelines to wait for an entry point of $270 and possibly $250 on the basis of declining profits.
Disclosure: I am long AAPL.
Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.