Amazon: All Smoke and No Fire?
Steven is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon.com (NASDAQ: AMZN) will go down in the history books as the company that changed the way the world competitively shops. It has put brick and mortar retailers on notice, potentially numbering their days. But just because they shot Jesse James doesn’t make them Jesse James.
Amazon’s aggressive culture of ruthless undercutting, big investing, and huge growth potential have been working together to boost shareholder conviction. The part of the equation left to debate is their earnings power once their reinvestment slows. Let’s look past the 300+ PE for a moment, because if they execute correctly, shares will grow into its seemingly stretched valuation. Should they fail to – best of luck to shareholders who are left riding the Tower of Terror.
Today we’re investigating if the supposed new sheriff in town offers enough promise for a perpetual long-term investor. We’re also going to examine if Amazon is willing to cannibalize itself in the name of growth.
Price Check in Aisle Four
In a world where prices have risen and wages remained flat, consumers flock to better deals. Amazon has capitalized on this trend by introducing a smartphone application that scans a barcode and looks up its price on Amazon.com. Within seconds, you know who has the better deal. This is a winning strategy and it has ticked off its fair share retailers.
Target (NYSE: TGT) has voiced frustration over becoming Amazon’s showroom. Over the holiday season, Amazon’s approach was to reward shoppers with a gift card if they used this application in a physical store. This really got underneath Target’s skin. They took it so personally, they no longer carry Kindles. Talk about a bad breakup.
The-Heartbreak-Kid, formerly known as Amazon, is likely to continue doing well with this approach, provided shoppers keep showing a willingness to defer their gratification. There doesn’t seem to be any evidence suggesting the contrary. Amazon Prime’s unlimited two-day shipping service now ships more items than its Free Super Saver Shipping option.
A Brief History Lesson
Companies that don’t study the failures of others risk finding themselves in similar predicaments. Amazon is currently walking the risky line that many have failed before. They are following an eerily similar path that Microsoft (NASDAQ: MSFT) is still digging itself out of more than a decade later. If history teaches us anything, Amazon’s cannibalistic tendencies shouldn’t be taken lightly.
When Xbox first debuted, it was sold at a loss to remain competitive against Sony’s Playstation 2. It was funded using profits from Office and Windows products. Having winning and losing divisions doesn’t always bode well for shareholder performance. “Making it up later” does not in any way guarantee future shareholder returns. Microsoft has made a plethora of bad investments in the past decade that investors today are still unwilling to justify a higher valuation. The longer a company has a bad reputation, the longer it sticks with them.
In the early 2000’s Amazon had a bad rapport period with shareholders. Investors were not pleased with their free shipping strategy that was costing the bottom line. It took years until the strategy paid off. The outcome of overcoming this criticism has made shareholders all the more confident in management’s ability.
It’s Risky Behavior
“We want to make money when people use our devices, not when they buy our devices.” Those words came from CEO Jeff Bezos and define what is known as the Amazon Doctrine. This is a scary approach for shareholders. They are taking a sizable risk by selling all new lines of Kindles at or below costs. Bezos has positioned Amazon as the crazy one in the room – the one willing to eat their own foot in order to grow their tail. But can a potentially bigger tail support a three-footed dog?
I’m not sure if Amazon deeply understands long-term shareholder implications of this action should they fail. They’ve delivered on past promises and this certainly helps promote their cause. But we all know that past performance is never indicative of future results, and risky behavior is still risky behavior.
Retailers have always had to differentiate themselves from their peers, and in that sense, nothing has changed now that they are going toe-to-toe with Amazon. Exclusive merchandise is still the name of the game. Costco (NASDAQ: COST) for the time being, is well insulated from the threat of Amazon. They already offer extremely competitive prices being a wholesale club with a huge economy of scale. And also, they have a very popular exclusive brand that offers consumers high quality and even greater value.
There has been chatter that Amazon should get into the exclusive branding business. Between AmazonBasics, a private label electronics accessory brand, and Amazon Pinzon, a bedding and bath label, they’ve already made some inroads. With this experience, it wouldn’t be so farfetched if they expanded further. As another value-added service, shoppers can sign up for Subscribe and Save. It’s a service that offers deeper discounts on household items if you subscribe to periodic shipments.
What’s that Saying?
A jack of all trades is a master of none. Could Amazon be diluting shareholder value by going into too many directions at once? Netflix’s (NASDAQ: NFLX) Reed Hastings has gone on the record that he would rather do one thing well than doing two things mediocre. Netflix delivers on that promise. They have kept it simple and remain the best video streaming service available. It’s true that Amazon is closing in on the leader, but unless their streaming service is spun off as a standalone product, it may continue to get lost in the shuffle.
The Road Ahead
When you invest for the perpetual long-term, the goal is to find the world’s best companies. Because Amazon is cannibalizing their business and are growing many businesses at once, I hesitate to call Amazon part of the world’s best.
Peter Lynch advocates when you invest in a company, you should be able to explain why in a few simple sentences. My first sentences would read: Amazon is the world’s largest online retailer that also sells books – a lot of books. This is their best skill. But beyond that, it’s unclear what I would want to say because they have so many tentacles. Between various forms of digital content, retailing, cloud computing, tablets, and private labels, the list keeps growing. Without this clarity, I’m not inclined to call Amazon a candidate for perpetual long-term investing. If Apple’s success provides any insight, consumers like a simple experience. Simply put, Amazon doesn’t come off as a straightforward company with a clear identity.
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TopDownTrends owns shares of Netflix. The Motley Fool owns shares of Amazon.com, Costco Wholesale, Microsoft, and Netflix. Motley Fool newsletter services recommend Amazon.com, Costco Wholesale, 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.If you have questions about this post or the Fool’s blog network, click here for information.