The Revenue Growth Story?
The truly great growth company accelerates revenue, piling up sales year after year. Investors buy these stocks high and then, buy them higher over and over again. Shareholders drive these much-loved shares into nosebleed PE territory. The high flyers tell a great story of things to come in the outlying years: The tale is told in "better-than-expected" sales.
Yet, ballooning sales often come at a cost: The sacrificial lamb being profits. Profits, for the ultra hot company, come later. The charging bull stock is usually about sales, sales, and more sales.
When the story ends, it usually does so in dribs and drabs: a hint of a little less growth here, a little less there. Nothing dramatic. Just a little disappointment in sales or cash flow. And suddenly, the stock is history, often dramatically. Witness Croc's (NASDAQ:CROX) tumble from grace from 2008 to 2009: a gut-wrenching drop from $72 to $1. To paraphrase Jimmy Cliff, the harder you climb, the harder you can fall, one and all!
In truth, most high multiple stocks over the year have gone higher. I ran a screen of $1 billion + companies with PEs of 50 or greater. Two-thirds of them ended the year higher. Love has no limits!
The Case of Amazon and Apple: Two MegaCaps Vying For Growth
Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) have made long-term investors rich. Both are higher by more than 400% in the last five years. Each has taken different approaches to achieving growth: Apple generates bountiful profits on strong revenue; Amazon is foregoing profits in order to take market share.
The market's vote for best grower
We already know how the market is voting. If the two companies were running for office, Amazon would win hands down. Amazon has a PE of 133, 10 times that of Apple. By the looks of their PE values, the market fervently believes Amazon can deliver growth, while Apple only can struggle. Amazon's sky high valuation indicates a confidence that the company will eventually earn boatloads of cash. After all, lots of growth companies don't deliver much in the way of earnings, sometimes for many years. Moreover, investors prize Amazon more highly than Apple on a price-to-book and price-to-cash-flow basis.
The market isn't being swayed by Apple's hefty profit margins or Amazon's wafer thin ones. Ever climbing iProduct earnings haven't boosted Apple's PE. By their respective valuations, the market is predicting that Apple and Amazon's earnings will someday switch places: Amazon will be coining money with Apple reduced to memories of profits past.
Let's begin the comparison.
Margins: The Parting Of The Way
Apple has been dramatically improving its margins. Amazon's margins have suffered. Here's where they stand now.
(Margins on a TTM basis)
And this is how each company has managed its margins since 2004:
And, the best earner is?
Apple's earning capacity has been nothing short of remarkable. Yearly income growth has been accelerating. Last quarter, earnings rose 116%, trouncing estimates. In contrast, Amazon's profits have faltered. In fact, earnings dove last quarter, dropping 58% from the previous year.
The final test: Revenue growth
Spectacular revenue growth defines the high PE stock. Amazon had been delivering accelerated revenue. Recently, Amazon experienced decelerating sales growth. Last quarter, growth slowed to 35%. Revenue outlook for next quarter is 22 to 36% over last year. Most likely Amazon's days of accelerated revenue are over.
Apple, on the other hand, is ramping up its revenue. It's the poster child of accelerated revenue growth: 52% and 66% in 2010 and 2011 respectively. The $400 billion company achieved 73% growth last quarter.
Apple has earned my vote (and money): Earnings, margins, and revenue have grown year after year. When it comes to Amazon, investors have to take a leap of faith. Earnings and margins have been going the wrong way while Amazon sales are starting to disappoint.
Next quarter is crucial for Amazon: The company forecasts revenue to come in 22% to 36% higher than last year. The company needs to reach the upper end of that range. Any less and investors may quickly fall out of love. In the meantime, investors have to be blinded by love to ignore that Amazon's PE is 10 times higher than Apple's.
Disclosure: I am long AAPL.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.