Amazon.com: Still a Great Growth Story

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer too. But some growth stories are inevitably better than others. Hence this regular series. My goal? Out the Fakers, elevate the Breakers, and examine the growth stories stuck in between.

Next up: Amazon.com (Nasdaq: AMZN  ) . Is the leading online retailer growing sustainably enough for your portfolio? Let's get right to the numbers.

Foolish facts

Metric

Amazon.com

CAPS stars (out of 5) **
Total ratings 5,319
Percent bulls 78%
Percent bears 22%
Bullish pitches 665 out of 967
Highest rated peers drugstore.com, PetMed Express, Acorn International

Data current as of Feb. 21.

Amazon is one of the most complicated businesses in tech. Retail may be its specialty, but it also develops products (i.e., the Kindle), hosts and accelerates delivery of websites and code (i.e., Amazon Web Services), is a source for online entertainment (i.e., Amazon Instant Video), and will soon operate a storefront for Android apps. Oh, and it sells books, too.

In the digital age, Amazon is the superstore we've come to trust most. And yet, in spite of its massive and ever-changing variety of offerings, the company has become a model of stable growth. Gross margin has held at or slightly above 22% since 2006. Returns on capital have kept between 13% and 19% over the same period. CEO Jeff Bezos and his team figured out how to squeeze maximum performance out of the e-commerce machine they built.

It's a model that's attracted growth and value investors equally. Fool co-founder David Gardner first recommended Amazon.com to Motley Fool Stock Advisor members in September 2002. Today, daily spikes of $15 or more result in what we call a spiffy pop on the Stock Advisor scorecard -- a 100% gain compared to the original recommendation price in a single day.

Legg Mason's Bill Miller is also a longtime backer of the stock. As the firm's chief investment officer, he's responsible for the roughly $270 million worth of Amazon stock held as of December. But he's been a buyer since at least 2006, when in a quarterly letter to shareholders of his Value Trust (LGVAX) fund, he listed Amazon as one of a handful of Internet names trading for half of intrinsic value. Turns out he was being conservative.

Today's Amazon continues to offer growth by putting pressure on competitors in multiple markets. Consider the Kindle e-reader. For as popular as the iPad and Barnes & Noble's (NYSE: BKS  ) Nook e-reader have become -- a Goldman Sachs analyst recently upgraded shares of B&N on the strength of Nook sales -- the Kindle remains a hot item. Amazon routinely says that its 6-inch Wi-Fi e-reader is the site's "No. 1 best-seller."

Cloud computing is also shaping up as a massive growth opportunity. In my recent interview with him, Rackspace Hosting (NYSE: RAX  ) CEO Lanham Napier all but conceded the low end of the market for hosting cloud-computing apps to Amazon.

"There's a clear segmentation developing in the [Web hosting] marketplace today, where we have Amazon offering a do-it-yourself commodity cloud. And then you have Rackspace, where we are trying to build the service leader in the cloud. If somebody wants the cheapest, do-it-yourself [cloud-computing infrastructure] ... they should buy from Amazon, [because] Amazon's doing an awesome job," Napier said.

The elements of growth

Metric

2010

2009

2008

Normalized net income growth 25.0% 43.6% 26.6%
Revenue growth 39.6% 27.9% 29.2%
Gross margin 22.3% 22.6% 22.3%
Receivables growth 60.6% 19.5% 17.3%
Shares outstanding (million) 451.0 444.0 428.0

Source: Capital IQ, a division of Standard & Poor's.

So the growth opportunities are there. Is Amazon capitalizing? By the numbers, I'd say there's no question. Let's review:

  • Growth investors like me love straight-line accelerating revenue growth leading to accelerating profit growth. We don't have that. What we do have is improving revenue growth combined with somewhat slower earnings growth. But that may sound worse than it really is. Cash from operations improved slightly over the past year and has more than doubled since 2008.
  • Pricing power is also something we like to see. Or, in lieu of that, excellent cost management leading to higher margins. Gross margin has remained mostly stable, as has net margin. I don't have a problem with that; Amazon is a retailer, and it needs to move product. Discounting is always going to be a part of the business.
  • We also like businesses that collect quickly. Here, Amazon excels. Last year, the company set a new record of negative 39.7 days for its cash conversion cycle. The figure illustrates how well Amazon is able to collect cash from customers versus paying its suppliers. Talk about impressive.
  • Finally, while dilution has been somewhat of an issue, it isn't uncommon to see tech companies suffer from options-fueled dilution. Growth usually overwhelms the givebacks, and that seems to be the case here, as well.

Competitor and peer checkup

Company

Normalized Net Income Growth (3 Years)

Amazon.com 31.5%
eBay (Nasdaq: EBAY  ) (0.7%)
Wal-Mart Stores (NYSE: WMT  ) 5.4%

Source: Capital IQ. Data current as of Feb. 21.

Amazon is clearly the top grower among its retail peers. eBay and Overstock.com, its closest competitors, underperform not only in terms of growth but also returns on capital, cash from operations, and cash conversion. Shares of Amazon may be pricey at 69 times trailing earnings, but the company's performance suggests the premium is well-deserved.

Grade: Sustainable
There's little reason to doubt Amazon's continued earnings power. E-commerce sales grew 15% in the U.S. last year, according to Commerce Department data. Consumers are also taking to online entertainment in increasing numbers, while developers and entrepreneurs are opting to rent rather than buy computing infrastructure. Amazon either leads or competes aggressively in each of these areas, and the company should continue to enjoy outsized growth as a result.

Do you agree? Disagree? Let us know what you think about Amazon.com's products, valuation, and competitive positioning using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.

Interested in more info on the stocks mentioned in this story? Add Amazon.com, eBay or Wal-Mart Stores to your watchlist.

Both our Motley Fool Inside Value and Motley Fool Global Gains services have recommended members purchase shares of Wal-Mart Stores. Amazon.com and eBay are Motley Fool Stock Advisor selections. Rackspace Hosting is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of PetMed Express and Wal-Mart Stores. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


Read/Post Comments (4) | Recommend This Article (5)

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 24, 2011, at 9:02 AM, younessi wrote:

    Stop pumping this stock. There has been almost no growth in earnings in the last 3 qtr.

  • Report this Comment On February 24, 2011, at 9:09 AM, swaprockz wrote:

    hi

    heres my review on various android markets...

    http://bit.ly/gg8n1B

    thanks

  • Report this Comment On February 24, 2011, at 9:14 AM, TMFMileHigh wrote:

    @younessi,

    >>There has been almost no growth in earnings in the last 3 qtr.

    Normalized net income growth data from Capital IQ:

    Q1: 62.2%

    Q2: 27.2%

    Q3: 19.7%

    Q4: (13.0%)

    Growth has slowed sequentially, but that hardly qualifies as 'almost no growth.' The thesis stands.

    Thanks for writing and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On February 24, 2011, at 4:18 PM, dgresl00 wrote:

    I agree with @younessi. This is a sales growth story, not a profit growth story. They have already said that profit will be DOWN 2-34% (quite a range but consistent for a company that doesn't like to disclose much) in the 1st quarter. At March 31, their earnings growth will be near flat for the prior four quarters. They will face increased shipping costs with $100 oil, their $79 Prime membership will only be used in the long run by those that ship regularly and will cut further into margins, and eventually they will have to collect sales tax for each state and compete on a level playing field with Best Buy, Wal-Mart, etc. ( see this article in Barron's http://online.barrons.com/article/SB500014240529702045869045... The valuation here can't be justified. Look at Target which just announced numbers today. Their trialing 12 month operating income is $5.25B and they have an enterprise valuation of $52B or right around 10x EBIT. Their earnings are actually growing at over 10%. Amazon has trailing operating income of $1.4B and will go down at March 31 and has an enterprise value of $72B or over 50x EBIT. In the long run, a $72B valuation needs at least $6B in cash flow and Amazon won't see that for at least 6-7 years, if ever.

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