Amazon: Do Profits Even Matter?

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

Last week Amazon.com (NASDAQ: AMZN) announced its quarterly earnings, and the results were less than impressive. The company failed to beat estimates both in the top and bottom lines, reported a loss, and yet investors still continued to buy the company. It looks as if Amazon investors don't really care about profits, and that the fundamentals don't really matter for the company.

Last quarter's results

Let's review last quarter's results first. In the quarter, Amazon was able to increase its sales to $15.7 billion, up 22% from the same quarter a year ago. The bad news is that the company's expenses grew at an even faster rate, pushing it into the loss territory. The analysts were expecting Amazon to post a profit of $28 million whereas it reported a net loss of $7 million. The company's management mentioned that it was spending a lot of money on new media content and warehouses.

Every quarter the company claims that it will post profits sometime in the future but says now is the time to invest heavily in growth. Amazon has been acting like a start-up company even though it's been nearly 20 years since its foundation. The company's revenue guidance for this quarter was also below the analyst expectations. The analysts were looking for revenue of $17 billion whereas the company guided between $15 billion and $17.2 billion, a midpoint of which falls to $16.1 billion. Despite missing on profits and margins in both the top and bottom lines, giving lower guidance, and having no idea when profits are coming, Amazon's share price continued its rally after the earnings report. 

The trend doesn't look good

Here are a couple charts I found at Zerohedge.com regarding Amazon's "growth story" in the last few years. The first chart shows how the company's net income has been in free-fall mode since 2010 and things don't look like they will improve anytime soon. It looks like the company's management started to realize how little investors care about Amazon's profitability, so they decided to let go of profits altogether. If any other company had a chart like this, its share price would be plunging day after day; however, this is not the case with Amazon, which outperforms the market consistently because people will continue to buy Amazon shares no matter what. 

The next chart demonstrates us how Amazon's operating margins are razor thin. The margins were never strong to begin with, but they are only getting worse. At this rate, we don't even know if Amazon will ever be able to post a profit. 

There are better alternatives

I like eBay (NASDAQ: EBAY) a lot better than Amazon as an investment. eBay is highly profitable mostly thanks to its subsidiary Paypal. The company also has higher margins than Amazon because it collects commissions on sales rather than building warehouses and selling people merchandise directly.

Last quarter, eBay's operating margin was 19.3% compared to Amazon's nearly 0.5%. Also, unlike Amazon, the company is highly popular in Asia where there are great growth opportunities. eBay trades for 22 times its future earnings (and the company has a history of meeting or exceeding estimates) whereas Amazon trades for 170 times its future earnings (that's if it even meets those estimates). 

More competition

Amazon also competes with brick-and-mortar companies like Wal-Mart Stores (NYSE: WMT) who are establishing themselves also as online stores. Wal-Mart allows customers to order products to be delivered to the nearest store location to be picked up within a couple of days. This business model also makes it easier for people to return products that they are not happy with. They can just bring the product back to the nearest Wal-Mart store and return it at the customer service desk rather than repackaging the product and shipping it off and waiting for a week before the product gets back to Amazon, hoping that it won't get lost in the process.

Wal-Mart also offers a dividend to patient investors with a current yield of 2.4%. Wal-Mart's operating margin is 5.6%, which is much lower than eBay's but much higher than Amazon's. Wal-Mart's current P/E ratio is 15 and the forward P/E ratio is around 13.5, which is much better than Amazon's and somewhat better than eBay's. Wal-Mart is great for conservative investors while eBay is for those who are looking for moderate growth; Amazon is for those that are looking for speculation. 

Conclusion

Amazon's share price decoupled from the company's performance a long time ago. Valuation doesn't seem to matter for this company at the moment. This poses a lot of danger for the current investors of the company because when a company's stock-price appreciation is not supported by fundamentals, things fall hard. We've seen this during the dot.com bubble and we may be seeing it again with companies like Amazon. Wal-Mart and eBay present better valuations for those looking to add a retailer to their portfolio.

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Jacob Steinberg has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. 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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