This Stock Is Priced for Perfection, but It’s Far From Perfect
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Regardless of what you’ve heard, there’s no such thing at the perfect stock. However, some companies do carry valuations that only operational perfection can justify. Clearly, these ideals appose each other. This makes liking a stock such as Amazon (NASDAQ: AMZN), which carries a P/E over 3000 extremely nerve-racking.
Then again, the tech sector is filled with these examples and Amazon has been trading on expensive valuations for years. However, growth has never been an issue for the retail giant. The company has proven time and time again that it can deliver the goods. Unfortunately profits have yet to arrive.
“If you Build It, They Will Come”
This seems to be Amazon’s M.O. The company has been more focused on building its infrastructure than netting profits. At this point it is a strategy and not so much of a problem with execution. Take the Kindle Fire for instance. The device is by far the closest rival to Apple’s (NASDAQ: AAPL) dominant iPad. Yet, despite selling millions of them, Amazon takes a loss on each one sold.
By Contrast, the iPad is considered Apple’s highest profit margin product. Then again, the difference is that Apple is in the hardware business, whereas Amazon makes money off content. In other words, Amazon will gladly trade the $200 (roughly) that it loses on each Kindle Fire for a chance to make that money back (and then some) by consuming future content on the device – be it books, music or movies.
To that end, I can appreciate that the company is spending to grow. However, the important question is, what can investors realistically expect from these investments. To date, the expectation has been growth. And Amazon has produced upwards of 30% of it each quarter. That’s all well and good. But what happens when that growth stops? And it’s not as if Amazon has not already shown some weakness.
When Will Profits Make The Agenda?
To date, profits have been kept on the backburner. And Amazon’s recent quarter failed to reveal any real urgency. The company did beat its own revenue estimates of $12.89 billion - reporting sales of $13.81 billion, which represented a year-over-year increase of 27%. This continued a string of revenue growth, which has averaged 34% over the past five quarters.
On the other hand, profitability remains the overhang. And management remains too nonchalant about it. Once again, with a net loss of 60 cents per share, profits fell short of analysts’ estimates of 8 cents per share. Essentially, after earning a profit in the previous three quarters, Amazon swung to a loss of $274 million.
It was encouraging however that the company managed to exceed its own operating income guidance - netting only a loss of $28 million versus $50 million. But unfortunately, investors will need to get use to these losses since Amazon is certain to enter the smartphone market this year. This means more infrastructure investments will have to be made.
According Taiwan Economic News, Amazon will launch the device sometime in the second or third quarter of this year. Interestingly, the report also suggests that the phones will be manufactured by Foxconn. If that names sounds familiar, it should. This is the same company that manufactures Apple’s iPhone.
Although Amazon often gets grouped with retailers such as Walmart and Best Buy, it is clear that the company has bigger ambitions beyond retail. That the company now wants to enter the smartphone market is not a surprise however. The shocker will be if the phones can yield a profit.
In that regard, it is not yet certain that Amazon will care. Clearly, the company operates in unconventional methods. But investors should. And to what extent Amazon can gain traction against Apple’s iPhones remains to be seen. But without question, in terms of ecosystem Apple has the clear advantage here. After all, aside from its retail stores, Apple enjoys great relationships with wireless carriers such as AT&T and Verizon.
Bottom Line
Amazon continues to be an incredible growth story. And in Jeff Bezos, the company has arguably the best CEO on the market. But as a value investor, the stock makes me sick. What’s more, with expenses soaring to 42% the recent quarter, growth continues to come at a huge cost.
Meanwhile, operating margins are on the decline. Essentially, high expectations are the only thing that keeps the stock trading at such an incredible premium. The company must execute to perfection to keep the stock from tanking at any point. Raise your hand if you’re perfectly sure that it will.
rsaintvilus is long AAPL and has no position in the other stocks mentioned. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com and Apple. 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!
