Slowing Growth Is the New Normal for, Inc.

After soaring to more than $400 in the last few months of 2013, shares of  (NASDAQ: AMZN  ) have dropped 14% in the last few days. Investors and analysts had been expecting a blowout holiday quarter from Amazon, but the results and outlook did not quite live up to expectations. 

AMZN Chart 6-Month Stock Chart, data by YCharts.

Amazon's revenue grew 20% in Q4, or 22% if you exclude the effect of exchange-rate changes. The company expects a similar growth rate next quarter, with sales up 13% to 24% year over year. 

Clearly, it's a high-class problem for revenue to be growing "only" 20% annually. However, that's a big step down from the astronomical growth rates Amazon has posted as recently as 2011. Indeed, as Amazon continues expanding, its growth rate will continue to moderate due to the law of large numbers. Amazon investors should recognize that this slowing growth will be an ongoing theme for Amazon over the next five years.

The law of large numbers
In investing, the law of large numbers states that the more a company grows, the harder it becomes for it to sustain its growth rate. At the extreme, as a company comes to represent a bigger and bigger chunk of the economy, its growth rate must eventually converge to the rate of GDP growth.

This process is already evident at Amazon. Over the last three years, the company has more than doubled its annual revenue, growing from $34.2 billion in 2010 to $74.5 billion in 2013. In dollar terms, Amazon's sales growth has been very steady. The company added $13.9 billion in revenue in 2011, $13.0 billion in revenue in 2012, and $13.4 billion in revenue in 2013. 

Amazon's growth is slowing in percentage terms.

However, in percentage terms, the declining growth rate is striking. In 2011, Amazon grew revenue by more than 40% year over year; last year, revenue growth was down to 22%.

Following in Wal-Mart's footsteps?
Amazon's slowing revenue growth (on a percentage basis) is very reminiscent of Wal-Mart's (NYSE: WMT  ) experience during the 1990s and early 2000s. When Wal-Mart was Amazon's current size, it too was growing about 20% annually. Yet revenue growth has been in a clear downtrend for more than two decades.

WMT Revenue (Quarterly YoY Growth) Chart

WMT Revenue (Quarterly YOY Growth), data by YCharts.

That's not to say Wal-Mart has stopped growing entirely. Analysts expect it to report revenue of $478 billion for its recently ended fiscal year, up from $422 billion just three years ago. Wal-Mart's absolute sales growth of $56 billion over that time period actually beats Amazon's absolute growth of $40 billion in annual revenue. However, in percentage terms, Wal-Mart's compound annual growth rate for the last three years is a pedestrian 4%.

In essence, Wal-Mart has become so big that it is basically impossible to move the needle. For example, it offered aggressive "doorbusters" on Thanksgiving this past holiday season, driving strong traffic that day. However, the company still turned in a weak sales performance for the full quarter because of macroeconomic factors. Wal-Mart already has such a large "wallet share" that its growth is tied firmly to economic growth.

So what?
A gradual slowdown in revenue growth from 40% to 20%, and eventually to 10% and below, need not be alarming. In Amazon's case, though, there's plenty of risk, because many investors seem to think Amazon can maintain a 20% growth rate almost indefinitely. As a result, the stock price has been driven up over the years so that Amazon now trades for more than 80 times expected 2015 earnings. 

If growth falls short of bulls' lofty expectations, Amazon stock could have more room to fall. Whereas other mass retailers like Wal-Mart and Costco trade for around 0.5 times sales, Amazon trades for more than two times sales.

Part of that premium is justified by the fact that Amazon is growing very quickly right now. However, even if Amazon's absolute revenue growth accelerates toward $20 billion a year in the next few years, its revenue growth rate would still cross into single-digit territory within less than a decade. By that point, if not earlier, Amazon will have trouble sustaining a lofty valuation premium.

Foolish bottom line
Amazon stock has been hit hard in the last few days because while growth has remained impressive, it has still fallen short of investors' expectations. Unfortunately, investors may be setting themselves up for future disappointments as well. For example, analysts at Credit Suisse still expect Amazon to maintain a nearly 20% revenue growth rate through the end of the decade!

The law of large numbers argues otherwise. Amazon's absolute revenue growth has barely budged in the last three years, despite the introduction of key new products like the Kindle Fire line of tablets. Amazon's annual revenue growth is unlikely to hit the $30 billion rate that would be necessary to keep growth near 20% for even five more years. In other words, slowing growth is the new normal for Amazon.

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Read/Post Comments (11) | Recommend This Article (2)

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 February 04, 2014, at 11:43 AM, hvedar wrote:

    This is a very lucid review, I enjoyed reading it. Thank you.

  • Report this Comment On February 04, 2014, at 4:09 PM, TMFGemHunter wrote:

    @hvedar: Thanks, I'm glad you liked it!


  • Report this Comment On February 04, 2014, at 6:37 PM, RoboSmart wrote:

    It would seem the current valuation is not sustainable. Is it time to remove AMZN as a core holding?

  • Report this Comment On February 05, 2014, at 9:45 AM, TMFGemHunter wrote:

    Personally, I think it's overly risky to hold AMZN stock at this point. But what's right for you obviously depends on your risk-tolerance, among other things.


  • Report this Comment On February 05, 2014, at 11:28 AM, creitsma wrote:

    Adam, this is an incredibly astute article & phenomenal analysis! Thanks!

    I would be interested to hear thoughts on how international growth and increasing profit margins post-"monopoly" factor in.

  • Report this Comment On February 05, 2014, at 1:32 PM, RobF wrote:

    Your analysis looks about right when viewing Amazon as an e-tailing business, but it's a hybrid and will only become more hybrid over time. There are a few more variables that will play into Amazon's ultimate growth over time although there is no escaping the overall trend based on large numbers as you say. Unlike Walmart, though, Amazon has a few more tricks up its sleeves to extend it's growth period. AWS is a powerhouse and as more businesses and governments move toward hosted solutions/BYOD, AWS is poised for even more growth. AWS' recent announcement of virtualized desktop instances in addition to the familiar virtualized server instances will also ramp up over time and win new converts. Amazon as a content distributor and creator along with its ability to empower individuals to publish their own work also looks promising. The Amazon marketplace allows Amazon to capitalize on other businesses more so than Walmart could and can take a few pages out of the eBay playbook for taking a cut on used/hard-to-find items. Then there are new areas that haven't been explored yet (payments, etc.). Of course, Amazon isn't alone in these endeavors, but it does command a large, satisfied customer base to which it can market.

  • Report this Comment On February 05, 2014, at 3:36 PM, msdds1 wrote:

    A better article then most on The Fool.

    So can't this be said about most of the beasts,

    Apple, Goog, etc.

  • Report this Comment On February 05, 2014, at 11:01 PM, Sanshan wrote:

    Amazon revenue of last quarter, was over 25 billion dollars and yet company still losing money, no profit for over 15 years. And I do not believe is going to be dividend either sometime soon. But Wall Street still treating it as the crown jewel of all stocks. You hear that from Jim Cramer and other respected analysts, saying Amazon never do wrong. Amazon add new category very year, the Kendal to compete with I pad, groceries to compete with food companies that count by thousands and cover almost every neighborhood in US cities and suburbs. They could increase revenue several folds but still no profit. Amazon is a good concept that will never work, when very company now could sell their products online and compete with Amazon on their core value of internet commerce.

  • Report this Comment On February 06, 2014, at 9:33 AM, TMFGemHunter wrote:

    @RobF: This cuts both ways. Wal-Mart's grocery business is more than half of its total sales: something like $250 billion at this point. I think it's very unlikely that Amazon will ever be able to build up a grocery business of that scale.

    AWS has a lot of growth potential, but it's coming off of a very small base and I don't think it is ever going to be a $100 billion business. Rackspace isn't a perfect comparison, but it's the closest thing there is to a "pure play" competitor, and it's valued at $5 billion. Even if you assume AWS is 5 times more valuable, it still makes up a small fraction of Amazon's total value.


  • Report this Comment On February 06, 2014, at 12:40 PM, ianstockportuk wrote:

    Amazon is not limited to the USA.

    As the 2nd world catches up with the 1st world and the 3rd would charges up with the 2nd world there will be lots countries Amazon can expand in.

  • Report this Comment On February 06, 2014, at 1:03 PM, TMFGemHunter wrote:

    @ian: Thanks for the comment. That's equally true of Wal-Mart, though. In fact, Amazon already gets a significantly higher percentage of its sales outside the U.S. than Wal-Mart.

    Waiting for the rest of the world to get wealthier over time may allow Amazon to grow at a high single-digit rate for several decades. However, that's still not enough to justify its current valuation, in my opinion.


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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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