Amazon (AMZN) has been an amazing company since its inception in 1994. It is the world's largest online retailer. It started out as an online bookstore but has since transformed itself into an e-commerce juggernaut that does businesses in areas as diverse as online retail, e-books, cloud-computing services, online video streaming and electronic consumer products. Jeff Bezos, CEO and founder of Amazon, has often been lauded as one of the best visionaries in the corporate world - his 19.5% ownership of Amazon makes him the 17th richest person in the world.
We should be well advised to chart the company's stock performance since its IPO in 1997:
I remember taking a look at this stock in 2006 when it was selling in the thirties. Let's say it was $35 on average which is a reasonable assumption. EPS for 2005 were $0.78 so the stock was trading at a P/E of 45. As of September 2012, the stock is selling at a P/E ratio of 321.3.
Jeff Bezos stresses year after year in his Letters to Shareholders that his goal is to maximize the Free Cash Flow per share in his company. Quote: "When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows."
This is an interesting statement, since the company's EPS (Earnings per Share) for the twelve months ended June 30 2012 were $377 million and the reported FCF (Free Cash Flow) according to Amazon's last 10-Q and the company's own calculation was $1.10 billion for the those twelve months ended June 30, 2012, compared to $1.83 billion for the trailing twelve months ended June 30, 2011, a decrease of 40%.
There is a great deal of difference between $377 million and $1.10 billion. If we take the company's reported FCF of $1.10 billion for granted the P/FCF is "only" 108.72 vs. the P/E of 321.3.
Whatever metric you place more trust in, even a P/FCF of 108.72 is too hefty a valuation for a firm whose sales growth, according to the newest 10-Q, is now falling from over 40% per year to closer to 30%.
Amazon.com sales growth and sales mix, six months ended June 30 2012:
Source: Amazon.com 10-Q of 30 June 2012
There is a reason behind the vast discrepancy that exists between Amazon's reported EPS and FCF. The reason lies in the accounting for the company's fixed assets.
Amazon has increased its fixed assets by 83% in 2011 while it increased its sales in the same year by 40.5%. Expenses for purchases of fixed assets, according to the company's Cash Flow Statement, were $1.811 billion in 2011. But SUPPLEMENTAL CASH FLOW INFORMATION shows fixed assets acquired under capital leases expense of $753 billion and fixed assets acquired under build-to-suit leases of $259 billion. These expenses are hidden in the Cash Flow Statement under financing and operating activities so the total purchases of fixed assets should be $1.811 + $753 + $259 = $2.823 billion.
Free cash flow of Amazon for 2011 was stated by the company's 10-K as $2.092 billion (net cash provided by operating activities of $3.903 billion less purchases of fixed assets, including internal-use software and website development of $1.811 billion). But this is overstating it, because the total purchases of fixed assets were closer to $2.823 billion as calculated above. If you subtract these purchases of fixed assets masquerading as leasing expenses from operating cash flows then the REAL Amazon FCF should be $3.903 - $2.823 = $1.080 billion for 2011. Also, you should subtract from this number the stock-based compensation of $557 billion (as it is a hidden expense) - common stock repurchased was $277 billion in 2011 so it is returned to shareholders, that means a "net expense" of stock-based compensation of roughly $280 billion. $1.080 - $280 = $800 billion - the REAL Amazon's FCF. FCF calculated like this gives us a FCF per share of $1.74 which is a far cry from the company's reported FCF per share of $4.54.
High P/Es are justified in a company that is growing at a very fast clip. But what about a company with falling EPS and FCF metrics? I suspect we will see some dark days ahead for the venerable Amazon.com. Making 0.01 cents per quarter does not augur well. The amazing momentum in Amazon's stock price that started in the depth of the financial crisis of 2008/2009 must end somewhere. The ride down will be very hard for those who hold a long position in this stock.