Amazon (AMZN) is one of the very few companies with premium valuation supported by the company's continual investments, rather than ongoing earnings, which is normally used for valuation on most companies. The market assumption with Amazon is that by putting in place all the infrastructure it needs for continuous growth, the company can eventually make money, and the payoffs will be worth all the investments.
Investors welcome stellar growth, but they do not easily lose sight of earnings. In the case of the Amazon, many have been willing to trade earnings for growth with a less stringent view on the company's return on equity (ROE), the ultimate financial metric used by investors to evaluate their investments.
- Amazon has invested heavily in its infrastructure and growth. Those investments are now paying off as the retailer has a return on equity—27%—that tops most competitors.
- Amazon’s ROE has grown nicely thanks to growth in net profit.
- Amazon’s ROE now tops that of Walmart at 18% and is neck-in-neck with Target’s 27%.
Historical Amazon ROE
Amazon's ROE has been all but stellar because the company isn't making enough money and it is incurring losses at times. ROE is measured as net income divided by total shareholders' equity. Amazon's most recent ROE, based on trailing 12-month data, stands at 27%. The net income is calculated as the sum of the quarterly net income from the four latest quarters, and Amazon is posting solid income.
For the last five years, Amazon's net income has been on the rise. During the same five-year period, Amazon's capital expenditures have increased every year, going from $4.6 billion in 2014 to $14 billion over the trailing twelve months, as its cash flow statement shows.
Pre-2016, Amazon was running a negative ROE given it was losing money on a net profit basis. Meanwhile, Amazon stock is enjoying the benefits, trading higher than ever near $1,800 a share.
ROE Comparisons and Projections
Since virtually no company invests the way Amazon does—sacrificing current earnings for continued growth and future payoffs—Amazon lagged its peers for a number of years. Amazon’s investments have paid off nicely of late.
Walmart, a close competitor of Amazon, kept its capital expenditures relatively flat over the last five years. On a trailing 12-month basis, Wal-Mart's ROE is 18%, now well below Amazon's 27%. This is a big change from many of the years leading up to 2018.
Amazon's heavy investments are contributing to the increase in its shareholder equity. With a larger equity base comes a stronger earnings-generating ability. When earnings growth surpasses the rate of equity accumulation, there would be higher ROE.
Amazon is now at the forefront of the diversified retail industry, which consists of Walmart and other retailers, such as Target, Macy's and Costco. The average ROE for companies with mid- to large-cap market capitalizations is mostly in the high teens percentage-wise, which is the case for Walmart, too.
Target, however, has an ROE that’s in line with Amazon at 27.9%. This comes as Target is a profitable, but not as profitable as Amazon. Profitability does play a role in projecting a company's ROE and may explain any potential ROE variations. Amazon has the strongest revenue growth, with revenue up 180% over the last five years. Reining in other costs may help Amazon improve its ROE overtime before its investments take their full positive effects in the future.