Amazon's Domination: Why You Should Hold This Company for Life

Carlos is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It is easy to forget, considering the rapid pace of technology these days, that online retailing is still a relatively recent development. After all, it has only been a mere 19 years since Amazon (NASDAQ: AMZN) started up. In that short time-frame, the company has gone from being a humble virtual store to becoming the greatest online retailer in the world, a company with a market capitalization of $122.49 billion dollars. Jeff Bezos, founder and CEO of Amazon, is worth around $18.4 billion these days, according to Forbes.

Not bad for a man that started an "online bookstore" in his garage.

What is really interesting, however, is the company's unique business model. Why is it intriguing? Because it's utterly confusing to most people.

Dissapointing performance...

As an illustration, let us look at their last quarter results that came out on Jan. 29.

The company reported 4th quarter revenues of $21.268 billion, which was below the expected $22.26 billion. Usually, missing expectations by such an amount (a billion dollars!) is enough to send people into a panic. Furthermore, their earnings per share ($0.21 per share) was also short of expectations, which were $0.29 per share.

Most terrifying of all was Amazon's guidance for the next quarter: the company said that first quarter revenues would be between $15.00 and $16.60. Wall Street analysts were expecting somewhere between $16.86 to 27.9%. That's right, the company's highest expectations doesn't even meet the lowest of Wall Street's official expectations. Furthermore, the company's guidance for their operating income (for those of you who don't know, that's the amount of profit realized after taking out operating expenses and depreciation) next quarter was somewhere between a loss of $285 million and a profit of $65 million. In other words, if you average that out, the company more or less expects a loss of $110 million. Now, I'm not really an expert, but that probably means that the expectations of $0.34 a share for the next quarter are optimistic. At best.

In sum: The company missed revenues, missed earnings, lost money in 2012, and issued terrible expectations for the next quarter.

For those of you who don't understand all that financial talk: it basically means that Amazon is pretty much doing THIS, working more like a charity rather than a profit making corporation. The general assumption would be that the company must have one terribad business model/plan.

How did the market react to all this news? The company's share price went from around $268 to a high of $290 (though as of the writing of this article, it's come back down to a more reasonable $266).

The lesson is simple: expectations mean absolutely nothing when it comes to dealing with Amazon. To analysts like me and the guys on Wall Street, this is akin to a form of witchcraft.

...but amazing results.

So Amazon, despite losing money, is continually expanding & growing so much that it practically terrifies all competition. Retail giant Target (NYSE: TGT) is implementing a price-matching guarantee so that the prices of goods in its stores matches with online prices for the same goods. Best Buy (NYSE: BBY), the big-box electronics retailer that is practically synonymous with buying consumer electronics, also implemented a price-matching guarantee (effective March 3) in order to stop "showrooming" (the practice of scoping out stuff in a physical store and then buying it online at a cheaper price).

This is a serious problem for both companies, according to the Wall Street Journal:

Another risk is that retailers run the risk of encouraging even more shoppers to check the Internet to compare prices, a comparison that doesn't favor the big box stores. A recent survey by brokerage house William Blair & Co. found that on average Target's prices were about 14% higher than Amazon's, Best Buy's were 16% higher and Wal-Mart's prices were 9% higher. The comparison included shipping costs for Amazon, but not sales taxes.

So matching prices and other moves (such as Best Buy's flash deals announced on Twitter) should help Amazon's competitors fight back in some ways. But there are some things that they just simply cannot affect. For example, customers who would simply prefer to order a product online and have it delivered quickly (thanks to Amazon's two day shipping service) rather than driving out to a big store. There's not much that the retailers can do to match this. Nor can they do anything about the fact that e-commerce is largely exempt from sales taxes at the moment. So regardless, Amazon still has a comparative advantage over it's various competitors.

How does Amazon achieve this? Founder and CEO Jeff Bezos himself explained a bit of this success (and his thoughts on the company's share price) during a Harvard Business Review interview:

ADI IGNATIUS: So how much do you care about your share price?

JEFF BEZOS: I care very much about our share owners, and so I care very much about our long term share price. I do not follow the stock on a daily basis, and I don't think there's any the information in it. Benjamin Graham said, "In the short term, the stock market is a voting machine. In the long term, it's a weighing machine." And we try to build a company that wants to be weighed and not voted upon.


ADI IGNATIUS: At what point will the goal change from lowering margins, building market share, to making a bigger profit?

JEFF BEZOS: Percentage margins are not one of the things we are seeking to optimize. It's the absolute dollar-free cash flow per share that you want to maximize, and if you can do that by lowering margins, we would do that. So if you could take the free cash flow, that's something that investors can spend. Investors can't spend percentage margins.

Free cash flow is cash from operations minus capital expenditures (the cost of warehouses, machines, distribution, cloud computing, etc). Bezos, as you can see above, is more interested in driving free cash flow than actually generating a profit for investors. Why? Because he believes that there is still plenty of room to grow and expand, thanks to the power of the Internet. He's ready to do anything to sell as much as possible for the lowest price possible, then reinvest almost everything that he makes into more low, low prices and expanding even further across the globe.

As any Amazon customer could probably tell you, this is all just fantastical. They get to buy practically whatever they want at prices that beat almost every other retailer.

As for those "other retailers," they're trying to figure out if there even is a way to compete with this madness. Not only that, but since Amazon is eeking out such a low profit, no one is even interested in competing for that market.

Professional investors, such as The Motley Fool (which I know holds a large amount of shares of Amazon, if their constant emails are any indicator), understand this concept. They're ready to stick it out with Bezos for the long run because in the end they'll end up controlling the entire market, and all colossal profits such dominance would entail.

Endless Expansion: 21st century style

Every day, we get news of Amazon doing something or other in order to grow or expand, whether it be entering new markets or building up its forces. It opened up Amazon Prime in Canada, and it's preparing to open up a "secondary market for digital products" (think Apple's iTunes combined with eBay, then add as many digital products you can think of and more). Its AmazonFresh grocery business is expanding into California, offering up a model that might one day put grocery stores out of business like it is doing to big-box retailers.

Even if the company loses money here and there, that has no effect on the bottom line. Amazon customers, already loyal and very pleased by the service and low costs, have no incentive to change to another retailer. And investors, so long as they're kept satisfied by unending growth, have no incentive to sell their shares.

So long as this is kept up, anyone who holds shares of Amazon (that includes Bezos, by the way, since he owns around 20% of the company) is going to end up a very wealthy and happy individual.

Halios has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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