Why Amazon Was Not Punished by the Market

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

You'd be surprised to know that Amazon (NASDAQ: AMZN) had a terrible second quarter, yet it seems that investors, instead of punishing the stock, are buying more shares, causing the stock price to rise. On July 26, Amazon had a disappointing earnings call: EPS came in at -$0.02 versus a $0.05 lowered consensus, while revenues came in slightly below consensus -- $15.7 billion versus a $15.73 lowered consensus.

At first, the stock price showed early signals of downward momentum, but the trend soon changed, and since then the price actually increased 2.84%. Why is this happening, and what kind of future awaits for Amazon shareholders?

Yet another miss and guide-down?

The small loss Amazon delivered isn't new. According to Seeking Alpha contributor Paolo Santos, who is bearish on the stock, there have been around 11 miss and guide-downs in a row. However, as the recent price increase shows, the Street doesn't find this worrying.

One of the reasons why the Street may not be punishing the stock is because everybody seems to understand that Amazon could be in the profit zone easily if it wanted to. Instead, it is choosing to invest almost all of its cash flow in new segments and in brand building. A clear example is giving free Amazon Web Services accounts to developers so they can get accustomed to the cloud first. Eventually, some of these investments are supposed to pay off, and in the meanwhile, some losses are expected to occur. But the fact that the stock price keeps increasing shows investors are willing to be patient. They are not looking for short-term annual profits and dividends, but they are sure that in the long-run these and many other rewards will materialize, if Amazon keeps investing smartly.

The good part of the earnings call

Even though revenue did not manage to beat the street consensus, Amazon keeps an excellent growth rate. Active users grew 19% to 215 million, third-party units sales rose 29% and total units sold increased 29%, making total revenue grow 25% (22%, after accounting for currencies fluctuations), which is still above the average growth rate for most e-commerce sites.

Amazon isn't just about retail

Compared with other retail stocks, it has one of the highest enterprise value to revenue metrics, three times the value for Wal-Mart (NYSE: WMT). Yet Amazon's annual sales volume is far away from reaching Wal-Mart's $469 billion. Why is the investor willing to pay more for Amazon?

We can't deny the enormous importance that Amazon.com has for the firm. The e-commerce site dominates the online retail landscape, with $51.7 billion sales in 2012, and is the main revenue driver. However, unlike your typical retail stock, Amazon's investments in Kindle products, Prime memberships and cloud farms show us that the firm's revenue components could be more diversified in the next three years. Some of these segments may experience amazing growth rates, and this is why the investor is willing to pay a premium for Amazon.

Global expansion

That doesn't mean that growth for the current cash cow segment, e-commerce, is over. Amazon.com has an enormous global opportunity that could multiply its current sales volume in the medium run. According to Morningstar, Amazon now sells directly only in nine countries outside of the U.S. and Canada. These 9 markets represented 43% of revenue in 2012.

If Amazon keeps expanding its e-commerce business globally, I believe it is perfectly possible to reach hundreds of billions in annual sales in the next decade. The current growth rate suggest it could take Amazon a decade to reach the volume of Wal-Mart, but acceleration due to emerging markets could make this shorter.

Is increasing & fierce competition a reason to be a bear?

So far we know that global expansion and investments in new segments, from Amazon Kindle to server farms, are driving expectations up. But how about increasing competition, coming both from traditional retail competitors (like Wal-Mart and its recent attempt to conquer the online e-commerce arena, also known as walmart.com) and e-commerce & auction marketplaces like eBay (NASDAQ: EBAY)? Can they ruin the party?

In theory, they can. The internet belongs to nobody and changes rapidly. Although it is catching-up quite late, Wal-Mart is a formidable competitor. It is creating a huge new logistics system, building new warehouses for web orders all over America. Even better, it is taking advantage of its more than 4,000 U.S. physical stores: it is asking its workers in stores to pack and mail items to customers directly, and it could improve the speed in delivery.

eBay, on the other hand, has presence in more than 40 countries outside the U.S., and international revenue already accounts for 52% of revenue. Some of these markets still have a low e-commerce penetration rate, and this is likely to change in the next few years. Considering eBay was an early mover in these emerging markets, it could have more competitive advantages than Amazon. And don't forget, eBay, like Amazon, is not only about retail. Now accepted by most online retailers, eBay's Paypal platform for online payments is a consolidated safe cash cow.

Luckily for its shareholders, Amazon does have competitive advantages. Unlike Wal-Mart, Amazon benefits from low-cost operations, since it doesn't need to maintain a large physical retail presence. And surely it has more e-commerce know-how: it has managed to build a strong online brand, and it is not so dependent on traffic coming from search engines, unlike most new e-commerce sites.

Also, not everybody is interested in auctions. Buying from Amazon sometimes can be much more simpler and faster than bidding in eBay. But I believe there is enough room for two giants to coexist in the e-commerce arena.

The bottom line

With more than $50 billion in annual sales, Amazon is still regarded by investors as a growth stock. This may be hard to believe, considering its e-commerce site has been around for more than 10 years. But recent investments in new segments, and global expansion could take revenue to new records. That's why investors pay a premium now and are not afraid of seeing some losses in the short run. It's not time to be a bear. It's time to be patient.

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