After having written about Amazon.com (AMZN) quite recently, and having dealt with the verbal fisticuffs that often follow articles on mass-appeal stocks like this one, I hadn't intended to return to the topic for a while. But as I looked through the comments following another quite interesting article comparing Jeff Bezos to Steven Jobs and Elon Musk, I saw something that poured cold water on what was an otherwise thought-provoking topic. One user comment bashed Amazon as follows: "Bezos? What is his great idea? To sell products cheap? How is that revolutionary? His margins are near 0."
First thing first. What's wrong with selling products cheap? Sam Walton revolutionized retailing through precisely such an obsession and made tons of money for himself and his shareholders. Consumers like cheap. This is a good thing. But that's not what induced me to write again on Amazon. The thing that got my goat was the assertion that Bezos' margins are near zero.
It's bad enough for one person to publish or post such a remark. The problem get much worse, though, given that this sort of assertion is repeated again and again with complete confidence by commenters and contributors. The problem is that it is misleading at best and at worst, false.
Evaluation of any company's margins involves several tasks.
First, we have to look up the actual numbers. You'd think that would be easy nowadays given the proliferation of free financial data, but judging from what I see way too often, this task alone seems insurmountable to many.
Second, we need a rational basis for deciding how to evaluate the numbers we see. If I tell you Company XYZ has a net margin of 15%, would you be impressed? Many might be. Suppose I were to add that Company XYZ is in an industry where the average margin is 25% and that XYZ's margins are the lowest, by far, in the group. Would you still be impressed?
Finally, and this takes a bit more analytic thought, we need to determine if the numbers we see should simply be noted "as is," or interpreted in light of distinctive circumstances, the task then shifting to a determination of what the situation will look like going forward once the situation stabilizes, for better or worse.
With these tasks in mind, let's assess Amazon's margins as shown in Figure 1.
Notice that I also included Wal-Mart (WMT). Given AMZN's sell-stuff-cheap strategy, we might as well evaluate its margins by comparing them to those of the master of this sort of thing.
While Amazon was erratic as it got off the ground (margins were negative before 2003), from 2007-10, it was generally in line with retailing's King of Cheap. So not only would it have been false to say Amazon's margins were zero, near zero, non-existent, etc., it would also have been false to characterize Amazon's margins as bad, low, etc.
Let's now move to 2011 and 2012 and probably 2013. Clearly, the margins are narrower and there is an expectation that it will go negative in the September period, and bounce back into plus territory in the fourth quarter and for all of 2012.
Seasonality is one thing that might be considered with many retailers losing money one, two or three non-Christmas quarters, but that's not the main explanation here. Both Amazon and Wal-Mart have shown themselves quite able to be profitable during the so-called off-quarters. The expected loss with Amazon relates to heavy spending on digital initiatives, delivery infrastructure, etc. Actually, this not only explains the expected third-quarter red ink, it also explains the margin downturn that began in 2011.
The wisdom of Amazon's spending initiative is hotly debated. On the plus side, great businesses need to be built; they don't appear fully formed on day one. Sam Walton had to do it. Steve Jobs had to do it. Michael Dell had to do it. Bill Gates had to do it. Etc., etc., etc., etc. Some, like Walton, did it long before the internet and blogs and financial media were invented. Bezos, on the other hand, is doing it with the whole world watching and debating every step of the way. Others started in the pre-information era but kept it going as times changed. Whatever the case, building a business is building a business and you need to spend money.
Whether you like Bezos' particular strategy or not (Seeking Alpha seems to attract quite a few who are enraged about it), one thing is clear. If Amazon wants to stop evolving the business and go forward as is, or as was before the digital push, it can and would likely be a profitable retailer with margins neck and neck with those of Wal-Mart. So if you have a problem with Amazon, you have a problem with its strategic choices and/or its stock valuation. You cannot have a problem with the business' margin characteristics. These are fine.
Modern investors are bombarded with opinions about Amazon (and, of course, many other companies), and it can be fascinating and often stimulating to weigh, balance and argue about the contending views. But when out-and-out nonsense is asserted and accepted as established fact, we have a problem, a big problem, a huge problem; a problem that is no less serious than the ethical controversies that plagued Wall Street a decade or so ago.
It's all well and good for modern investors to rejoice in the information revolution and improved ethical standards. But what's the point of having so much information so readily available if people don't bother to actually use it? What's the point of sincere and ethical analysis if people prefer to latch onto obvious nonsense?
Making a good decision regarding Amazon is challenging enough as it is given that Bezos and his company are running so hard and that the stock's valuation is expecting so much. The last thing you need is to obfuscate your task by listening to nonsense. So when you see a factual assertion, wherever it comes from, don't accept it without verifying its accuracy for yourself. The information revolution is here, so use it to your advantage.