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

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

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

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.