- We think there are better companies to analyze than Amazon.
- Management is going to keep spending shareholder money, with little regard to accounting profits.
- The company's equity is highly speculative until a focus on generating cash flow becomes paramount.
Amazon (NASDAQ:AMZN) continues to focus on taking market share and damaging its competitors, rather than generating large accounting profits and cash flows. The company's cash-flow generation should improve if investments turn out to be profitable (and management turns off the expense gushers), but the company remains a low-margin retailing operation. The market has recently grown impatient with the executive suite's lack of profit focus, and reaction to its second-quarter results, released Thursday, couldn't have made this point more clear.
For a company that boasts a market capitalization of ~$146 billion, one would think the firm is highly profitable. For Amazon, however, this just isn't the case. We explain why the firm garners such an elevated valuation (despite meager profits) in this article here. The large sell-off in shares today is largely due to the view that expense gushers at the firm will remain wide open and it may be some time before Amazon turns its focus to generating gobs of free cash flow. CFO Tom Szkutak reiterated the point that Amazon has "a long-term view… (and)… we're not trying to optimize for short-term profits." Though we generally like a long-term focus by management teams, Amazon was founded in 1994 - it has been 20 years!
We're not going to write up an elaborate quarterly review for Amazon, because we don't think this is where you should spend most of your analytical firepower. The company is a wildly speculative entity because of its meager profitability, and just like today, drops of 10% or more can almost be expected, at times. The major takeaway from the firm's second-quarter earnings release is that the firm's third quarter will face significant pressure on the operating line. Management guided to an operating loss of between $810 million and $410 million, compared to $25 million in the third quarter of last year. Clearly, the profit focus is not yet part of Amazon's strategy.
We don't include Amazon in the newsletter portfolios, and we don't see much of an opportunity in shares, even after its large price drop. The company's business model has a tremendous amount of operating leverage, and even a few basis points of mid-cycle operating margin deterioration or improvement could have significant implications on our estimate of the firm's intrinsic value.
Could Amazon's shares bounce back to $400? Yes, but they can easily fall to $200, and we wouldn't think anything of it. We view holders of Amazon's stock as speculators, not investors. Our Best Ideas are included in the Best Ideas portfolio. As for e-commerce exposure, eBay (NASDAQ:EBAY) is worth a look.
Additional disclosure: EBAY is included in the Best Ideas portfolio.