Buying This Stock Makes No Sense; Neither Does Selling It

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

Despite the constant bear references to Amazon’s (NASDAQ: AMZN) massive P/E of 3000, the stock just keeps making new highs. Shares are just too expensive. Then again, the tech sector is filled with these examples. Plus, Amazon has been expensive for a decade. But at some point, something’s got to give.

Today, investors are paying for growth. And growth has never been an issue for Amazon. The company has proven time and time again that it can deliver the goods – to your door and during each earnings announcement. With fourth quarter earnings on tap for Tuesday, Amazon’s P/E will either come down or rise – in either case, this will be good news for investors.

'If you Build It, They Will Come' Works

The company is coming off a solid third quarter, during which Amazon beat its own revenue estimates of $12.89 billion by reporting $13.81 billion. Not only did this advance revenue 27% year-over-year, but it continued Amazon’s string of performances where it has averaged 34% revenue growth over the past five quarters.

On the other hand, the company’s challenge continues to be profitability, which again fell short of analysts’ estimates. Amazon reported a net loss of 60 cents per share, which was significantly lower than analysts’ estimates of 8 cents. Too, investors grew concerned about the company having swung to a loss of $274 million after having earned a profit in the three previous quarters.

Then again, Amazon did exceed its own operating income guidance, netting a loss of $28 million versus the $350 million it had projected. Investors were torn. While profitability is a legitimate concern, the rate of growth remains impressive. In other words, selling the stock and locking profits made sense. But it seemed foolish to abandon a company of Amazon’s size that is growing at a rate of 34%.

Besides, Amazon is still building its infrastructure. And as Netflix (NASDAQ: NFLX) recently proved, the strategy of “If you build it they will come” works. Although the constant bear argument against Netflix has been rising expenses, Netflix’s recent quarter serves as the perfect example of how this can become overblown -- proving that expenses are not always the enemy of profits.

While the Street expected Netflix to report a loss of 13 cents, instead the company reported a 13-cent profit. This is while beating its revenue number by posting $945 million – representing 8% growth year-over-year. Likewise, Netflix managed to make meaningful improvements in costs as general expenses declined by 30%. Why not Amazon?

Plus, Netflix proved that it can continue to grow subscribers at an impressive rate – adding 2.05 million domestic streaming subscribers plus 1.81 million outside the U.S. All of which occurs while there were across the board improvements in margins.

For Amazon, the comparison to Netflix is interesting because both companies compete in the same market for movie streaming as Amazon’s prime have proven a worthwhile threat to Netflix. This means since Netflix enjoyed a surge in subscribers, there’s also a chance that Amazon may outperform its subscriber targets, which leads us to this quarter.

Expectations for Q4

Overall, the Street seems positive about Amazon’s Q4 – despite the expected dip in profits. Analysts will be looking for earnings to come in at 29 cents per share, which will represent a 24% year-over-year decline. Then again, that estimates have fallen from 50 cents per share over the past two months have not hurt the upward movement of the stock.

For the full fiscal year, analysts are expecting a loss of 3 cents per share. However, (as noted) revenue will be the big story. For the quarter, the Street is looking for sales of $22.28 billion, or 27.8% growth year-over-year. Likewise, for the full fiscal year, revenue is projected to come in at $62.1 billion.

What Is Amazon Today and Where is it Heading?

This is the question investors are struggling to answer – especially when it centers on whether to buy or sell the stock. As noted, the $274 million loss amassed in Q3 snapped Amazon’s streak of earnings in the previous three quarters. But as in the comparison to Netflix, it’s not uncommon for companies such as Amazon to struggle with profitability.

Plus, even though the company is sometimes grouped with Wal-Mart due to the retail side of its business, Amazon is not operating like the mature company that Wal-Mart is. Too, Amazon has much bigger ambitions than retail. To that end, investors should appreciate that the company is spending on growth opportunities.

For that matter, a case can be made that Amazon is more of a tech company than it is retail. That the company has plans to launch a phone this year serves as a perfect example. And reports suggest that the phone may be released as early as the second or third quarter. I’m certain that management will be asked about this on the conference call on Tuesday.

This move is the logical next step for Amazon, which already sells the popular Kindle Fire that competes very well with Apple’s (NASDAQ: AAPL) iPad. And any traction that Amazon can make in phones will serve to narrow the gap between itself and Apple and also with Google (NASDAQ: GOOG). Seeing as Apple has started to lose some of its cache by having missed iPhone sales estimates, now may be the perfect time for Amazon to step on Apple’s neck.

However, Amazon’s model has always been different and how it hurts Apple's iPhones will be based on the price point. That each Kindle Fire tablet is sold at a lost speaks to Amazon’s strategy. In other words, an Amazon phone might only serve to fulfill its infrastructure-building focus and not profitability – at least not yet. For that matter, it may be outside of Apple's market.

And let's assume it is. I’ve made this point before, but imagine what would happen if Amazon chooses Research In Motion’s (NASDAQ: BBRY) BB10 for its phone operating system. It seems far-fetched since Amazon’s Kindle Fire already runs on Google’s Android. But there’s a clear strategy at play here as it could impact the growth of both Apple and Google.

Essentially, Amazon would be taking out two phone rivals with one decision. And an Amazon/RIM partnership will help bring more balance to market while giving Amazon time to catch up. Not to mention, it will also raise RIM’s profile. This question should certainly make its way to Jeff Bezos during the conference call.

Bottom Line

Amazon continues to be an incredible growth story. And in Jeff Bezos, the company has arguably the best CEO on the market. Although profitability is placed on the back-burner, at some point in will matter.

However, until that time comes, investors will continue to marvel at Amazon’s marvel and loathe Amazon’s valuation. While a case can be made to sell the stock today and be smart by securing profits, it nonetheless feels like a dumb decision. By the way, did I mention that Apple is cheap?


rsaintvilus is long Apple and has no position in any other stocks mentioned. The Motley Fool recommends Amazon.com, Apple, Google, and Netflix. The Motley Fool owns shares of Amazon.com, Apple, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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