Has Amazon.com Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock and then decide whether Amazon.com (NASDAQ: AMZN  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Amazon.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

32.7%

Pass

 

1-year revenue growth > 12%

27.1%

Pass

Margins

Gross margin > 35%

24.8%

Fail

 

Net margin > 15%

(0.1%)

Fail

Balance sheet

Debt to equity < 50%

53.5%

Fail

 

Current ratio > 1.3

1.12

Fail

Opportunities

Return on equity > 15%

(0.5%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

2 out of 9

Source: S&P Capital IQ. NM = not meaningful because of negative earnings. Total score = number of passes.

Since we looked at Amazon last year, the company has lost another point after dropping two points from 2011 to 2012. A big jump in the debt-to-equity ratio was responsible for this year's decline, but the stock has once again ignored the score decline, soaring more than 40% over the past year.

Amazon has shown its ability to diversify into a huge number of different markets. Having demonstrated its superiority in online retail, Amazon has greatly broadened its scope, moving into the mobile-device market with its Kindle Fire tablet, the cloud-computing industry with its Amazon Web Services unit, and the video-streaming business.

But Amazon has simply never shown investors that it's truly interested in maximizing profits. Just last week, the company cut its price on its Kindle Fire HD tablets by $30 to $100, making them more competitive with the smaller iPad mini but suggesting that Amazon was having trouble ridding itself of inventory. Despite assurances from CEO Jeff Bezos that the company is trying to get customers into its ecosystem before reaping more income from them over the long haul, earnings have been moving in the wrong direction for two years, and the company posted its first yearly net loss in a decade during 2012.

Moreover, with so many fronts to defend, Amazon faces competition on all sides. Netflix (NASDAQ: NFLX  ) has reinvigorated its competing video-streaming service with huge content deals that will force Amazon either to pony up for its own premium content or face permanent second-class status. Retailers are ramping up their own websites to compete on the retail front, and multiple failures of Amazon Cloud Services last year have inspired Rackspace Hosting (NYSE: RAX  ) as a primary hosting alternative, as well as countless other competitors in the growing Big Data space.

For Amazon to improve, it needs to make good on Bezos' assertion that a transition to higher-margin profitability is coming. Otherwise, Amazon may keep growing yet never produce the bottom-line results that would make it anything close to a perfect stock.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Despite this somewhat pessimistic view of Amazon, many people are convinced that it's destined for greatness. Find out whether Amazon can justify its sky-high valuation by reading our premium research report on the e-retail leader. The report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.

Click here to add Amazon to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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