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Amazon's Got a Bad, But Familiar, Habit

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

For fans and investors of Amazon.com, Inc. (NASDAQ: AMZN), the last couple of quarters have been tough. The organization was spending a lot of money to develop and launch the surprisingly successful Kindle Fire, and is still in the midst of what's becoming an overhaul of its entire shipping and storage process. Rather than a few, centralized distribution sites, Amazon is building out several smaller ones, with the ultimate goal of better (read 'faster') shipping service.

While the truly faithful have accepted the recent troubling numbers - by staying focused on the light at the end of the tunnel - many of the financial media's pundits haven't been as kind. Investors have had to tolerate headlines and complaining comments like:

  • Amazon Continues to Invest Heavily to Grow Top Line
  • ...capital spending [is] taking a toll on profit
  • Another headwind could be placed on Amazon's margin growth in the form of rising capital expenditures.
  • Lately profits have fallen, dragged down by spending on new technology projects
  • Amazon... needs to increase spending just to keep up with the market

Ugh. Don't they get it? Amazon has to spend money now in order to get to the big enchilada in the future.

There's just one problem.... not one of those statements was made within the last two quarters. Only one of them was made within the last year.

Oh, they could have been made within the last two quarters, and we've all certainly seen more than a few comments like the ones above. This last above, however, is made up of comments and observations that extend all the way back to 2005. I'm 100% confident I could find similar observations and comments that go all the way back to 2000.

And that's the problem.

I'd be the first to (proverbially) stand up and shout from the rooftop that you have to spend money to make money. That includes Amazon. Yet, I'd also be the first one to stand on the same rooftop - likely by myself - and shout that a decade of excessively high capital expenditures has yet to get Amazon to that promised land of profits. Capital spending has increased every year since 2002, from $89 million in 2005 to $1.8 billion last year. Granted, revenue has increased during that time as well, but margins have gradually slipped rather than improved during the whole time.

Point being, the company is forever doing something now for a better tomorrow, forgetting the fact that a lot of tomorrows have come and gone, yet profits have yet to be tremendous. If anything, they’re getting worse.

Tough to See

Don't get me wrong. There's nothing inherently wrong with the company. Jeff Bezos built something from nothing, and has made it profitable. The top and bottom line have grown tremendously too, from 1999's sales of $2.6 billion to last year's $48 billion. 2011's income of $631 million isn't too shabby either (and that was on the low end of the recent range of bottom lines).

Make no mistake about the red hot growth, however - Jeff Bezos bought it all with heavy capital expenditures, scraping just a wee bit o' profit out of the cash flow.

But hey - that's still more than some companies can say, right?

So what's my beef? It's with the stock's valuation. It presently trades at 181 times trailing earnings, which is a figure that would fly for no other stock I'm aware of. Funny thing though... AMZN hasn't traded under 30 since 2005, when it broke into the black and stayed there. The P/E hasn't been below 50 since 2009. At what point is the market going to - in poker parlance - call?  

I know, I know... valuations are so yesterday, and I'm a relic for worrying about them more than I'm impressed by growth. Well, this relic has been around for longer than he cares to admit, and he's seen this kind of thing end badly before, even when it wasn't supposed to (a la Netflix). At some point Amazon is either going to have to start turning more of its revenue into a profit, or adjust the stock's price with about a 75% haircut to better reflect earnings. Trouble is, after a decade of getting comfortable with what most would consider very excessive CapEx, Amazon.com may not be able to wean itself from its spending habits – the heavy spending is the only thing spurring the growth, and that growth may be the only reason investors have remained tolerant.

Is This Time Really Different?

For investors' sake, I hope I'm wrong and that 2012 really is the turning point. We've heard that idea opined more than once too.... errantly. Check this out:

  1. "I suppose the positive side of the story is that Amazon capital expenditure has plateaued."
  2. "In 1999, Amazon spent $320 million on capital expenditures. This year, the number should drop to between $200 million and $250 million. Overall, the number should continue to slide from there."

The pros were wrong on both counts, and it's hardly the only times that's been the case over the past several years. You get the idea.

Folks, despite what the company says, Amazon isn't spending to get ahead because it wants to. It's spending to keep up, because it has to. The former is the kind of proactive approach you want. The latter is troubling because the results are rarely long-lasting.

Last week's announcement from Google (NASDAQ: GOOG) is just another example of how Amazon's heavy investment in a presumed future cash cow can be chopped up into just another low-ROI project. How so? The debut of Google's Nexus 7 takes dead aim at the Kindle Fire price point, but with what's apt to be deemed a better product. It’s a stark turnaround from the euphoria of six months ago, when all the R&D spending on the Kindle Fire was going to usher in a new era of prosperity by beating Apple at its own game. Now the Fire is just another tablet, offering Amazon no real competitive advantage… just a lot of bills.

Before that it was storage/cloud. It’s a viable product for Amazon, but not the game-changer it was supposed to be since the same is now available through dozens of companies.

And content? As Netflix (NASDAQ: NFLX) began to implode due to ill-advised pricing changes against a backdrop of higher costs, Amazon prepared to take over the digital content business (largely on the back of the now-lackluster Kindle Fire). It looks as if Amazon is now learning what Netflix learned a year ago, though… a lot of other digital content players are getting into the game too. Cable companies and cable networks like Showtime and HBO, along with former-fringe-players like Hulu, are now competitors too.  

It begs the question: How much does Amazon need to spend on its next great idea, since the last several of them have been trumped? A couple of years of true investment in future growth is forgivable. It’s been ten years of this crazy spending though, with no real end in sight.

Oh, and if you want proof I wasn't just making random headlines up....

jbrumley has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Google, and Netflix. Motley Fool newsletter services recommend Amazon.com, Google, and Netflix. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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