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When Will Amazon Start Making Real Money?

Sometimes I wonder just how much hair has been lost trying to predict exactly how  (NASDAQ: AMZN  ) stock will react following quarterly earnings reports.

Last quarter, for instance, Amazon stock hit an all-time high in the days after the company not only missed analyst estimates for both revenue and earnings per share, but also lowered its guidance.

This time around, after what seemed like perfectly decent results, shares of Amazon dropped like a sedated 800-pound e-commerce gorilla before finally closing down more than 7%.

Amazon stock 

Image source: Wikimedia Commons.

So were the results really that bad? Let's dive into the numbers to find out. 

For the first quarter, net sales rose a whopping 22% to $16.07 billion, falling just short of analysts' expectations of $16.15 billion. However, note that Amazon's reported revenue also included an unfavorable $302 million impact from year-over-year changes in foreign exchange rates and so otherwise would have exceeded estimates.

Operating income decreased 6% to $181 million, including a $12 million hit from foreign exchange rates, and net income fell 37% to $82 million in the first quarter, or $0.18 per diluted share. Curiously enough, that number nearly doubled analysts' estimates, which called for net earnings of $0.10 per share. 

So why did Amazon stock get punished? Look no further than management's second-quarter 2013 revenue guidance of between $14.5 billion and $16.2 billion, which amounts to year-over-year growth somewhere in the range of 13% to 26%. In the end, even if management is conservative, the middle of their range sparked short-term fears of decelerating growth given analysts' average revenue estimates of $15.9 billion next quarter.

The multibillion-dollar question
Even so, it's becoming increasingly evident that one question remains on investors' minds: When will Amazon start making the big bucks?

After all, while its gross margin did rise to an all-time high of 26.6% last quarter, both its operating and net margin remained razor thin at 1.1% and 0.5%, respectively. As fellow fool Evan Niu pointed out recently, Amazon's historical bottom line looks downright silly next to other ridiculously profitable tech companies like Apple (NASDAQ: AAPL  ) , which just last week told investors it earned $9.5 billion (with a "b") on sales of $43.6 billion.

If Amazon were as profitable as Cupertino, then, simple arithmetic tells us it would have earned around $3.5 billion on last quarter's revenue instead of that measly $82 million.

To Amazon's credit, it still generates plenty of cash from operations, which itself increased 39% to $4.25 billion for the past 12 months. In addition, had Amazon not spent $1.4 billion on property and corporate office space in Seattle last quarter, free cash flow would have come in at around $1.58 billion.

So why do investors put up with it?

The wonders of properly managed expectations
In the end, this is exactly how Amazon CEO Jeff Bezos told shareholders he would run the company when it went public in 1997. In fact, in Bezos' first letter to Amazon shareholders, he wrote the following under a subhead titled "It's All About the Long Term" after discussing the company's laser focus on establishing market leadership:

Our decisions have consistently reflected this focus. We first measure ourselves in terms of the metrics most indicative of our market leadership: customer and revenue growth, the degree to which our customers continue to purchase from us on a repeat basis, and the strength of our brand. We have invested and will continue to invest aggressively to expand and leverage our customer base, brand, and infrastructure as we move to establish an enduring franchise.

Later in the letter, Bezos was unapologetic in stating, "When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows."

In the end, then, nobody should be surprised by Bezos' consistent refusal to manage Amazon around earnings. Instead, just as he said he would, he has done a fantastic job expanding Amazon's customer base, brand, and infrastructure, and it's safe to say his company stands tall as one of the few truly enduring franchises our country has to offer.

Foolish final thoughts
But don't get me wrong; I'm not trying to say investors will never see the day Amazon's profitability helps it grow into its outsized traditional valuation. In fact, I'm convinced that day will arrive.


However, to answer the multibillion-dollar question of when that will be, I'll turn once again to Bezos' words from 1997:

We aren't so bold as to claim that the above is the "right" investment philosophy, but it's ours, and we would be remiss if we weren't clear in the approach we have taken and will continue to take.

Considering Amazon stock has returned more than 14,000% since then, I'd say they know a thing or two about what's "right." In the meantime, impatient investors might do well to settle down and enjoy the ride.

More expert advice from The Motley Fool
Everyone knows Amazon is the king of the retail world right now, but at its sky-high valuation, most investors are worried it's the company's share price that will get knocked down instead of its competitors'. The Motley Fool's premium report will tell you what's driving the company's growth, and fill you in on reasons to buy and reasons to sell Amazon. 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.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 27, 2013, at 10:22 AM, sajmal wrote:

    First, I own Amazon puts.

    I've watched Amazon for 10 yars. Profit profile is worse than the airline industry. Yes, GM is improving, but because business profile is changing. Amazon (Retail) is low margin, low expense industry. To this mix, they are adding content, a high margin, high expense category. So anyone looking at GM improvement should pay attention to the expense line, too. Doing one withut the other is doing incomplete analysis.

    Bears should also pay attention to the Sales Tax issue. This is not trivial. Yes, they could do better than EBAYs sellers. However, there is not a 5-9% price differencial with brick and mortar to absorb the sales tax. B&M gives instant acces and gratification.

    Last available advantage is broad selection. That one is hard to overcome. Even BestBuy etc, will strucggle with that. You cant buy clothes and furtniture and electronics and... from BestBuy online. Walmart is just catering to a dirrerent audience.

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