For a company that has generally been very good at what it does, Amazon (Nasdaq:AMZN) gets no small amount of flack for its strategic decisions. Whether it's the decision to compete with Apple (Nasdaq:AAPL) in the tablet and digital media spaces, or its move into markets such as business-to-business MRO retailing and cloud services, there's no shortage of carping about Amazon's margins and its proclivities toward "empire-building."

And yet, Amazon has been a painful company to short. While there have been some notable swoons, the stock is up more than 250% over the past five years - well ahead of eBay (Nasdaq:EBAY) and Google (Nasdaq:GOOG) and on par with Apple's returns given the latter's recent fall from grace. Though I've long been an Amazon bull and believe this company has more innate margin and free cash flow (FCF) potential than the current numbers show, I think valuation is plenty rich for today.

Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.

Mixed Notes for Fourth Quarter
Amazon's fourth quarter numbers were OK, but the stock is likely to do well as the company outperformed on the one metric (operating margin) that analysts and investors seem most concerned about today.

Revenue rose 23% on a constant currency basis, about 4% shy of analyst expectations. Not only did this mark a meaningful deceleration from the prior quarter (up about 30%), but unit growth of 32% was weaker than expected. Likewise, media revenue was up a relative unimpressive 10%, while the company's small "other" category (which includes its cloud services operation) was up more than 60%. The core merchandise segment saw revenue increase 28%.

Margins were meaningfully better this time around, lending some credibility to the idea that the company has some leverage here. Gross margin improved almost three and a half points, helped by better shipping performance/costs and a higher proportion of margin-rich computer services. Operating income rose 56% as reported, while pro forma operating income increased 47% - leading to a half-point improvement in margin.

SEE: 6 Things To Look For In Earnings Reports

Time to Leverage Fulfillment?
Amazon bears/skeptics are right when they point to several years of margin declines, but I think they err in assuming that it's a lasting mark of Amazon's deficiencies. Amazon has been spending aggressively on fulfillment in recent years - adding locations, workers, equipment, and so on. That created overhead ahead of demand and pressured margins.

Now I believe the company can push in the other direction and start reaping margin leverage. Rapid shipping is a potential competitive differentiator against the likes of Walmart (NYSE:WMT) and Target (NYSE:TGT), and one that the company can now really utilize. Moreover, as the company continues to grow and ship more product, that overhead will be absorbed and margins ought to improve.

The one fly in the ointment is international. There's still plenty of on-the-ground investments to be made in areas such as China, Brazil and Russia, and the extent to which Amazon decides to invest for growth in these regions could create a repeat of this margin cycle (though likely smaller in scale given the relative revenues involved).

SEE: 5 Of The Richest Companies In Developing Nations

New Ventures Hold Risk, but Plenty of Opportunity
When it comes to Amazon's empire-building, I'm curious to see how it will all work out. While Amazon is one of the only companies to make any real dent in the Apple/Samsung tablet war, the Kindle family hasn't been a profit center for Amazon. What's more, it's still up in the air as to whether it will really give the company any sort of durable edge in the on-demand media market against the likes of Apple, Netflix (Nasdaq:NFLX), Hulu and so on.

The company's web services operations, however, are another story. Between cloud computing, storage, database management, app development, middleware and e-commerce, Amazon can do a lot for businesses (particularly smaller businesses) at lower cost than what large software players such as IBM (NYSE:IBM) and Oracle (Nasdaq:ORCL) are willing to offer. Assuming that Amazon can maintain the same sort of customer service-oriented culture, I give the company a better than average chance of grabbing meaningful share in an addressable market measured in the tens of billions of dollars.

SEE: Is Cloud Computing An Investable Trend?

The Bottom Line
Not many companies can do one thing well, let alone more than one, so I can appreciate some of the skepticism about Amazon's corporate direction. The fact that management is not always very transparent about its plans, the cost, and the interim performance doesn't help matters. Still, I think a key point is often lost in the worry - what a company sells is often pretty trivial compared to the company's customer service culture and back-office abilities, and Amazon excels at both.

Even though I like Amazon's direction, I'm not so enamored of the price. Mid-teens revenue growth and gradual improvement in free cash flow conversion sufficient to produce high-teens free cash flow growth is only good for a fair value in the $290s today. That suggests Amazon is no particular bargain today, though past experience will keep me following this one in case another significant pullback opens up an opportunity to buy at a good price.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Investing News

    Why the Philippines Is the #1 Source for Tech Startups & Talent

    In the last few years, the Philippines has been working diligently to re-invent itself, and that work has paid off. The Southeast Asian nation is rapidly gaining notoriety as a leading source ...
  4. Investing News

    Austin Set to Rival Silicon Valley

    Over the years, Austin, Texas has lovingly embraced its quirky reputation with the slogan “Keep Austin Weird.” Today, the capital city is attracting several tech startups and investors, making ...
  5. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  6. Stock Analysis

    The Biggest Risks of Investing in Amazon Stock

    Find out which risks are most important to Amazon's shareholders. Learn which operational risks impact share prices and which financial risks affect investors.
  7. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  8. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  9. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  10. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!