Amazon's Earnings Don't Justify Price

By Sham Gad | April 27, 2012 AAA

Amazon (Nasdaq:AMZN) finally gave Wall Street the quarter it was waiting for. This week Amazon reported that first quarter revenues grew by 34% to $13.2 billion compared with the year ago quarter. Net income was $130 million, or 28 cents per share, compared with $201 million, or 44 cents per share a year earlier. Despite the year-over-year fall in net income, Amazon's quarter blew past average analyst estimates of EPS of 7 cents and revenue of $12.8 billion.

Shares Rally

Not surprisingly, the market was ecstatic with Amazon's pleasant surprise. Shares lept by over 12% on the earnings news. Trading at $225, shares are now nearing the 52-week high of $246. Despite the good news, investors continue to build in a lot of future expectation for Amazon. Currently shares trade for nearly 200 times earnings as investors continue to pile in for the ride with the world's largest online retailer. The eventual expectation is that Amazon's online dominance will lead to significant profitability. But for now, the company continues to aggressively invest in its business in order to maintain its online dominance. Amazon's recently spent $775 million acquiring privately held robot maker Kiva Systems.

Razor-Thin Retailing

In addition to acquisitions, Amazon continues to aggressively price its products in order to maintain the lowest prices. The company is known to under price products like its Kindle e-book reader, choosing to instead make up for loss from the purchase of e-books. It's the classic razor/razor blade model: accept a loss or low return on the device and make your money on residual purchases. Currently, that has yet to happen for Amazon. Operating margin in the quarter came in at 1.5% while net margin was 1%, respectively. At the moment, Amazon has the growth rate of a tech company but the margins of a tired traditional retailer. Wal-Mart (NYSE:WMT), the world's largest big box retailer has net margins of 3%. Wal-Mart generates over $400 billion in annual sales while Amazon does about $50 billion.

Amazon's fantastic sales growth is why many investors are willing to pay 200 times earnings for the growth; the hope is that one day Amazon will be the Wal-Mart of online retailing. But for now, Amazon's valuation makes other sizzling growth stories like Chipotle (NYSE:CMG) and Whole Foods (Nasdaq:WFM) seem much more palatable at 57 times and 47 times earnings, respectively. Both these businesses are experiencing significant top and bottom line growth as consumers gravitate toward their differentiated products.

The Bottom Line
Amazon will have to continue delivering the goods, but more importantly, start showing improving profitability margins. Otherwise, investors could be in for a quick disappointment.

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