Amazon Earnings: Why so Expensive?

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

The world’s biggest online retailer, (NASDAQ: AMZN) has done very well for its shareholders.  Over the past decade shares have grown from $9.03 in 2002 to the current level of around $272 as of this writing, for an outstanding 2,912% gain.  In other words, $10,000 invested in Amazon 10 years ago would be worth approximately $301,200 today!  Talk about a great return!  My hat is off to anyone who had the foresight to buy then. 


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However, some investors (myself included) think that the prudent move for Amazon shareholders is to take some, if not all, of their profits off the table.  This company has been a great investment for its shareholders, but I have some serious questions.  First and foremost, how can Amazon continue to justify its ridiculous valuation?  A stock trading at well over 100 times forward earnings had better be producing some growth, but not so much in this case.  In fact, there doesn’t seem to be a clear trend of earnings growth in Amazon in the past decade.  To put this in perspective, compare the earnings charts of Amazon and Google (NASDAQ: GOOG), which trades at a much cheaper P/E ratio, I should add.


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If the high valuation is indeed justified, I want to know why.  Is Amazon about to increase its earnings tenfold after such a long time of barely any earnings growth?  

Amazon’s competitive advantage has been its ability to undercut retail stores and to provide an easy, convenient shopping experience.  Without the overhead that stores have, such as rent and utilities (Amazon has these to some extent, but on a much smaller scale), they have traditionally been able to do just that.  However, this has also been one of Amazon’s shortcomings. In order to undercut actual retail stores (as well as other Internet retailers), Amazon operates at a relatively small profit margin, so a great volume of sales generates only a small amount of earnings.

What Amazon does have going for it is its size and strong brand name recognition.  With virtually unlimited “shelf space,” Amazon offers an enormous variety of products sold by either themselves or third parties who pay Amazon a percentage of sales.  In addition, new products such as the Kindle e-reader and Kindle Fire tablets should provide a new revenue stream going forward, especially as digitally available content increases.

Another strength of Amazon is its extremely solid balance sheet, with more than $9.5 billion in cash and no debt as of the 2011 year-end results.  I would be very surprised if Amazon’s cash position didn’t increase further this year, as the company is on pace for its highest revenues yet.

Consensus estimates call for earnings to grow to $1.74 per share in 2013 and $3.94 in 2014.  Even backing out the $12.38 in cash Amazon has per share, the company still trades for 69 times 2014’s earnings.  That’s better than the recent multiples of hundreds of times earnings, but I’m not sure this level of growth justifies the valuation. 

So, what would need to happen for me to become bullish on Amazon?  Either the share price needs to drop considerably or there are certain things I would need to hear from the company.  I would need to hear a concrete plan to turn their revenues into a significant amount of earnings for their shareholders.  While earnings are expected to more than double between 2013 and 2014, how does the company plan to sustain a high rate of earnings growth.  In order for me to feel that the high valuation is justified, I would need to anticipate sustained 30%+ earnings growth for the foreseeable future, and I just don’t see it right now.  If all the company can muster is $1.37 per share from the almost $50 billion in revenue it took in during 2011, why should I think the earnings will grow going forward? 

KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends and Google. The Motley Fool owns shares of and Google. 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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