Earnings at What Price?

By Ser Jing Chong - September 5, 2012 | Tickers: AMZN, AAPL, GOOG | 0 Comments

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Amazon (NASDAQ: AMZN) has been an amazing company since its inception in 1994. It started out as an online bookstore but has since transformed itself into an e-commerce juggernaut that has businesses in areas as diverse as online retail, e-books, cloud-computing services, online video streaming and electronic consumer products. Jeff Bezos, CEO and founder of Amazon, has often been lauded as one of the best visionaries in the corporate world and it should not surprise us if he has even more plans up his sleeves to make Amazon even mightier than its namesake river.

Amazon’s stock price has seen a tremendous 14,000% increase since its May 1997 IPO closing price of $1.73 to its current price of $246 in August 2012. That is a testament to Amazon’s growth in its business since its inception. Even though Amazon survived the 1999 dot-com bubble and prospered through the horrendous 2008/2009 financial crisis, its stock price has often confounded traditional ‘value investors’. As an example, its stock was trading at a PE of 300 from its August 30th, 2012 closing price of $246. Amazon’s business has grown at a breakneck pace for 15 years and the fact that its stock price has defied ‘financial gravity’ got me very interested in the magic of Amazon. Thus, I took a closer look at how Amazon’s balance sheet and income statement had evolved from 2002 to 2011, a period that encompasses 10 Fiscal Years. The changes to their balance sheet are presented in the table below.

Table 1 – Selected Financial Data for Amazon (numbers in billions)

Table 2 – Income Statement for Amazon for FY 2002 and FY 2011 (numbers for columns 1 and 2 in millions)

From 2002 to 2011, Amazon’s market cap increased from roughly $5 billion to $78 billion. During this period, Amazon has poured $25 billion back into its business for growth. What is interesting here is that even as Amazon invested more than $25 billion into its business, its income only managed a $740 million increase from 2002 to 2011. Investors in Amazon have been paying $73 billion for a $740 million increase in earnings during those 9 years. That relatively paltry increase in Amazon’s earnings ($740 million) compared to the increase in assets ($25 billion) seems to me that Amazon’s heavy reinvestments into its business might not be as attractive and accretive to future earnings as others might suggest.

For a comparison, we can take a look at how the balance sheet and income statement of fellow technology giant Apple (NASDAQ: AAPL) has evolved over the same time period.

Table 3 – Selected Financial Data for Apple (numbers in billions)

Table 4 – Income Statement for Apple for FY 2002 and FY 2011 (numbers for columns 1 and 2 in millions)

For the corresponding period, Apple’s market cap increased from roughly $7 billion to $310 billion. Apple poured $110 billion back into the business while earnings increased from $65 million to $26 billion. In essence, investors paid $303 billion for $26 billion in earnings for those 9 years. When comparing what Apple’s investors and Amazon’s investors have paid for the earnings, it would seem that investors in Apple have been paying for much better quality, or ‘foundation of earnings’ so to speak.

Even Google (NASDAQ: GOOG), who has been criticized for engaging schizophrenically in a variety of non-earnings accretive business ventures prior to Larry Page’s appointment as CEO, had its investors pay only $160 billion for a $9.3 billion increase in earnings from FY 2004 to FY 2011 (Google had its IPO in 2004, hence there was no concrete market cap data for them in 2002).

Just looking at the numbers alone seems to highlight the fact that Amazon’s investors have been paying a hefty premium over the years for its earnings, even when the investment dollars that Amazon’s management have poured into the business does not seem to have paid off in terms of earnings.

In my opinion, I think Amazon is a great business that will continue to shape the world of e-commerce and cloud computing in the years to come. However, its investors might not be in for such a good time 5-10 years down the road. Amazon has been given amazing leeway by growth investors over the past 15 years, but there has to come a point in time where the earnings and price relationship will have to matter. There will come a time when investors are no longer willing to pay hundreds of dollars for every dollar of earnings and when that day comes, Amazon’s earnings might not even be able to support a PE in the teens for investors who are buying in now. When will that happen? I do not have a working crystal ball to answer that question, but all I know is that as much as I believe in Amazon’s business performance, its future stock price performance might just move in an opposite trajectory.

If I am proven wrong, there will be a great lesson to be learned from the Amazon saga. But until then, I’m happy to sit on the side lines and continue to observe Amazon trying to change the world - for the better. 

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