What Jeff Bezos Gets That Amazon's Critics Don't (NASDAQ: AMZN  ) has generated a cumulative $315 billion in sales since 1997. Its cumulative profits during this period are less than $2 billion. Its lifetime profitability, then, is about a half of 1%. Pitiful.

This might be normal for a start-up, but if Amazon were a person, it would be old enough to vote and buy cigarettes. Companies its age usually aim for steady and reliable profits. Amazon doesn't. It reported a small loss last quarter. All the company seems to care about is revenue, revenue, revenue. Predictably, more critics are stomping their feet and wondering when -- or if -- CEO Jeff Bezos will shift tactics and attempt to turn a real profit.

They should stop, and recognize that Bezos knows exactly what he's doing. He is not running a shareholder-owned charity. It's quite the opposite. His indifference to profits today reflects his deep understanding of how retailers maximize income in the long run.

Here's what Bezos knows: High margins are hard to maintain for any company. For a retailer, they are nearly impossible. Competition drives them into the ground, and the low-cost provider always wins. That's how capitalism works. Look at the most profitable retailers in the world -- they all have razor-slim margins. Wal-Mart's net income margin was 3.6% last year and Costco's was less than 2%. Compare this to the S&P 500 average of nearly 9%. Retail just isn't a high-margin business.

In any commodity-type business that is destined for low margins, there is only one way to increase the total dollar amount of net income: Grow revenue. Forget increasing margins beyond anything but a trivial amount. It's not going to happen. Size should basically become the sole focus. Here's how Bezos once put it:

Percentage margins are not one of the things we are seeking to optimize. It's the absolute dollar free cash flow per share that you want to maximize. If you can do that by lowering margins, we would do that. Free cash flow, that's something investors can spend.

If Amazon is destined for low margins, the goal should be to become as big as possible as fast as possible. That's how you maximize the dollar amount of net income for long-term shareholders. By investing like crazy and forgoing short-term profits, it's exactly what Amazon is doing.

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  • Report this Comment On October 30, 2013, at 1:28 PM, XXF wrote:

    Try doing the math on their market cap:

    Amazon shows no sign of paying out a dividend in the near future but is valued at $130B. That market cap is theoretically the present value of future cash flows to the shareholders. If we expect AMZN to begin returning cash to shareholders in 10 years (which would probably mean Bezos is gone, since I don't expect him to ever pay back his financial backers) and expect a 10% annual return on our investment we'd expect a PV of $340B in 2023.

    To justify that at the same 10% return they would have to be in a position to return $34B to shareholders a year in perpetuity at that point. Looking at their cash flow for the last 4 years, they've grown net cash from operations just under 9% per year since 2009, if they continue at that pace they'll be creating just under $10B a year in cash flow from operations a decade from now and that doesn't even account for their necessary perpetual reinvestment in warehousing assets.

    Obviously there is some rounding involved, but there is just no way now and no way ever that AMZN can grow fast enough to to justify their current valuation.

  • Report this Comment On October 30, 2013, at 4:35 PM, AltReality11 wrote:

    I own not a single share of Amazon. That's what I think of Bezos and his approach.

    Back in 1999, his tagline was "We aren't a bricks and mortar company and we don't need this." Shortly thereafter he began building "brick and mortar" distribution centers.

    I prefer to invest in companies with better management, better work ethics, which provide dividends and get "exemplary" ratings for management, etc.

    Now, that's not easy to do, but 3M gets a vote, and there are a lot of other, similar companies.

    According to, the median wage for a picker at Amazon is $11.25. That's certainly better than "minimum wage." But then, AMZN is not a low tech, fast food, no skill company.

  • Report this Comment On October 30, 2013, at 4:40 PM, cmfhousel wrote:

    << But then, AMZN is not a low tech, fast food, no skill company.>>

    I may be wrong about this, but I'd assume the skill requirements of a picker isn't terribly high.

  • Report this Comment On October 30, 2013, at 8:04 PM, NOTvuffett wrote:

    Hey Morgan, it would be nice to see a graph of AMZN's gross revenues- otherwise I thought this was a well written article.

  • Report this Comment On October 31, 2013, at 11:55 AM, constructive wrote:

    "It's the absolute dollar free cash flow per share that you want to maximize."

    And up until recently they were successfully doing that. In the last year cash flow has fallen off a cliff.

  • Report this Comment On October 31, 2013, at 1:32 PM, ETFsRule wrote:

    AMZN has burned through more than $4.2B in cash over the past 3 quarters, plus they issued $3.3B of long-term debt in Q4 2012.

    Revenue growth is nice, but if Bezos judges himself on cash flow generation, the past year has been a dismal failure.

  • Report this Comment On October 31, 2013, at 1:46 PM, pondee619 wrote:

    What is a fair value for revenue with no, or little, earnings?

  • Report this Comment On October 31, 2013, at 3:35 PM, Becker2011 wrote:

    1. Great article Morgan. I appreciate the possible insight on what Jeff Bezos is aiming to achieve.

    2. I find it very interesting that comments are attacking the business versus just the price/valuation of the company. I think Amazon is a fantasic company - and for cash flows if you can spend $4 billion a quarter on building your business - while not taking out similiar amounts of debt - that shows what your capable of. (yes they took out debt once in 2012 but look at 2009-11)

    Valuation-wise. I agree with all the over-valued comments. But just making the argument here that valuation and business model are very different things.

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