5 Things to Consider Before Investing in Amazon

These five things may add clarity to your Amazon investment thesis.

Feb 9, 2014 at 9:30AM

If you're assessing whether or not to invest in online conglomerate Amazon (NASDAQ:AMZN) you may want to ponder its qualities as a business, its prospects, and its standing against competitors such as discount chains Wal-Mart (NYSE:WMT) and Target (NYSE:TGT). The five items below may add clarity to your decision making process.

Competitors faltering
According to Reuters, Wal-Mart faces struggles on many fronts most notably lower customer traffic due to cuts in the federal food stamp program. Roughly 20% of Wal-Mart's shoppers utilize food stamps. This is where Amazon's limited exposure to the low end grocery market helps it. Wal-Mart suffers from issues on the international scene such as bribery scandals and difficulties in nailing down the consumer spending dynamic in places like China. Moreover, it faces foreign investment issues in India where it lost the partnership with Bharti Enterprises. Indian law requires 49% local ownership in any venture into India with a foreign business such as Wal-Mart.  Target faces ongoing public relations fallout from its data security breach in November. On Feb. 4, Target executives endured tough questioning by the U. S. Senate where they apologized for what happened.  By contrast, Amazon maintains a solid reputation for online security.

Consumer trends favor Amazon
Many pundits observed the slow shift from traditional "brick and mortar shopping" to online and mobile platforms. Even Starbucks CEO Howard Schultz expressed concern in his latest earnings call  and realigned his senior executive team to counteract it. According to the latest data available e-commerce comprises 6% of total U.S. retail sales up from just 2% 10 years ago. 

Solid fundamentals
Amazon's focus on operating cash flow rather than reported earnings resulted in controversy over the years. With that said Amazon's revenue grew an impressive 22% in 2013. Its net income stood at $274 million versus a loss of $39 million last year.  However, operating cash flow continued its six year upward trajectory growing 31% during 2013 . Amazon also possesses a solid balance sheet with $12.4 billion in cash and investments on hand. Its long-term debt to equity of 33% is less than the 38% reported in 2012 .

Don't worry about price increases
Amazon wants to raise the price of its Amazon Prime service by about $20 to $40 per year. As of this writing it remains undecided as to the exact amount of the increase. Increased popularity of the service resulted in increased Internet bandwidth costs for its streaming videos and fuel costs for its package delivery. According to Amazon's latest earnings call, executives seem committed to maintaining and improving the quality of the service by adding original programming.  As long as Amazon remains devoted to customer service and if it communicates in a way that's not offensive to the customer base then the price increase shouldn't affect Amazon's long-term investment prospects.

Amazon Fresh just beginning
Amazon started out in 1995 as an online bookseller. It's expanded into a vast online shopping portal where you can buy clothes, shoes, electronics, art, and groceries. Amazon started Amazon Fresh where it delivers groceries in the Los Angeles, San Francisco, and Seattle areas.  According to Amazon's latest earnings call, Amazon executives like some of the preliminary results of the venture meaning it will probably continue and expand this line of business. 

Foolish takeaway
Amazon still faces plenty of room for expansion on the international front. In addition, Amazon's penetration into the grocery segment is just starting. Groceries will slowly increase in economic viability as Amazon builds up its fulfillment infrastructure. Amazon built seven new fulfillment centers in 2013 alone. As long as Amazon maintains its customer centric philosophy it will continue providing long-term capital gains for its shareholders.

As for its main competitors, Businessweek estimates that Wal-Mart will grow revenue only 2%  and that Target's revenue will actually decline 1% in 2014 . Wal-Mart currently is in the process of cutting overhead that will most likely accelerate bottom line growth. However, its needs to find new avenues of growth such as its current expansion into the dollar store and the Canadian  market.  Target told congress that it's working on new technologies to curb identity theft which should be available in 2015. However, both Wal-Mart and Target may want to consider investing more into their online infrastructure. Consumers increasingly tire of fighting crowds in the confines of a store.

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4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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