The Secret Behind Amazon’s Stock Price
Dave is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
This earnings season has been brutal on companies who disappoint on earnings, revenue or guidance. For examples of the carnage, look no further than Priceline (NASDAQ: PCLN), dropping more than 17% after warning about lower revenues in Europe. And then there’s Netflix (NASDAQ: NFLX) where a “miss” on subscriber count caused the stock to drop 25%. Not Amazon. The company’s last earnings report was certainly less than stellar, missing earnings estimates, lowering revenue guidance and surprising analysts with a projected third quarter net operating loss. Yet the stock is up almost 9% since that time. What gives?
Much of Amazon’s woes in the second quarter were due to massive investments the company is making in its infrastructure, opening new fulfillment centers and increasing investments in everything from cloud computing servers to Kindle to a rumored smart phone to compete with the Apple (NASDAQ: AAPL) iPhone. Uncharacteristically, the market has been very patient, allowing time for these infrastructure and development investments to pay off in the longer term.
Actually, it’s not uncharacteristic at all. The key is to understand what drives Amazon’s stock price. Let's start by looking for a correlation between TTM earnings and the stock price. You won't find one.
OK, how about TTM Free Cash Flow? Nothing there either.
Let's try one more. What about TTM revenue? Bingo.
In the near term, when your margins are as low as Amazon's (operating margin was only 0.8% in the second quarter), you need revenue to make money. Lots of revenue. Of course, in the longer term, investors are hoping that Amazon's margins will expand, converting today's new revenue streams into tomorrow's profit. Either way, it's no surprise to see this correlation continue in a quarter where Amazon is making massive investments in future potential revenue.
Understanding that Amazon investors are drawn to revenue like a moth to your front porch light can give insight into evaluating Amazon's valuation. As I write, Amazon's P/E is near 300 and their Free Cash Flow Yield is 1%. Both of these metrics look as stretched as a rubber band, historically speaking. But the Price/Sales ratio (which is based on revenue) is right smack in the middle of its historical range:
What's the upshot here? While Amazon's last report was nothing to write home about and other valuation metrics are somewhere in the stratosphere, investors care about revenue. By that measurement, there seems to be plenty of room for this stock to run.
VTDave is not an investment professional. He owns shares of Netflix and Apple. The Motley Fool owns shares of Apple, Netflix, and Priceline.com. Motley Fool newsletter services recommend Apple, Netflix, and Priceline.com. 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.