Amazon.com Marches Ahead in Quest to Take Over World

Investors are clearly impressed with Amazon.com's (NASDAQ: AMZN  ) third quarter results, as shares reached an all-time high above $368 on Friday and closed 9% higher following the company's earnings release. What of course begs the question, what is a Foolish investor to think?

Why are investors excited?
Amazon.com continues to outperform the market thanks to tremendous top line sales growth. For the third quarter, Amazon.com's sales increased 24% to $17.1 billion and exceeded analyst expectations of $16.8 billion. This increase is sharply contrasted by relatively soft retail data; for example, brick and mortar competitors Wal-Mart Stores (NYSE: WMT  ) and Target (NYSE: TGT  ) are expected to report revenue growth of less than 3% in next month's earnings releases.

As discussed at length in previous articles, Amazon.com's growth is unique in both its impressive rate and diversity of contributors. For example, management stated that the company signed up "millions" of new subscribers to Amazon Prime. At $79 per year, this can quickly add up to a sizable source of recurring revenue. Meanwhile, Prime is a tremendous value for customers that also increases customer loyalty and purchase volume. Amazon.com's recent release of the Kindle Fire HDX continues another trend in market share accumulation through the offering of an unmatched value proposition to customers. 

Prime and Kindle are just two examples of how Amazon.com is positioning itself for sustainable long-term revenue growth. Amazon.com's "other" segment, which includes Amazon Web Services, reported growth of 58% in North America during the quarter; AWS is projected to reach $1 billion in quarterly revenue in the fourth quarter. Amazon.com is still in the initial stages of growth in initiatives ranging from same-day grocery delivery to expansion into China and India. In short, there are plenty areas of growth that are just starting to be tapped

Still no earnings
Skeptics of Amazon.com are quick to highlight the fact that the company reported a net loss of ($0.09) per share. While this loss was in line with analyst estimates, Amazon.com's deliberate decision to sacrifice near-term profits for long-term growth continues to make the investment thesis a difficult one to grasp. While it is hard to justify Amazon.com's valuation based on normal profitability measures as a result of these near-term sacrifices, it is important to note that the company's trailing twelve month price to sales ratio remains less than 2.3.

A TTM P/S ratio of 2.3 doesn't sound like a bargain against the backdrop of Wal-Mart and Target's ratios of 0.5, but it is important to remember that Amazon.com also competes against companies like Apple, Netflix, and Rackspace Holdings in a range of mobile device, digital media, and cloud computing businesses. Each of these companies trades at a P/S ratio higher than Amazon.com's.

A good metric for looking at Amazon.com's success while excluding the impact of investments for the future is operating cash flow; operating cash flow for the past year reached $4.98 billion, an increase of 48% over the prior year. This strong growth illustrates the ability of Amazon.com to generate significant amounts of cash to continue to grow the business or eventually return to shareholders.

The primary difference between Amazon.com's GAAP operating cash flow and net income is the treatment non-cash charges associated with depreciation, amortization, and stock-based compensation. For example, Amazon.com's GAAP TTM net income was weighed down by almost $3 billion in depreciation and amortization charges for investments made in past periods that did not impact cash inflows and outflows during the past year; this depreciation and amortization represents an increase of $1.1 billion over the prior year and is the direct result of Amazon.com's aggressive expansion to prepare for future growth. As a result, Amazon.com's net income isn't reflective of how results would look absent this investment.

Looking ahead
For investors interested in Amazon.com, looking ahead to the future remains far more relevant than reflecting on the past. In the upcoming quarter, management expects to deliver revenue between $23.5 billion and $26.5 billion; the top end of this range represents a 25% increase in sales, which is a remarkable figure given relatively subdued expectations across the retail world for the holiday season. 

There is little doubt that Amazon.com will continue this growth trend for the foreseeable future and expand its leadership position in e-commerce. Once the company reaches sufficient scale, management can begin to truly leverage the position it has built to ramp up profitability. At that time, $368 per share will seem like a bargain. Ultimately, that remains the reason to invest in Amazon.com for as long as management continues down its current path.

Failure of management to remain on the present course or game-changing competition shifts from retailers such as Wal-Mart and Target would be valid reasons to rethink this investment thesis, but short-term valuation concerns should not scare away long-term investors. 

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  • Report this Comment On November 08, 2013, at 11:42 PM, RyanPeckyno wrote:

    I am interested to see WMT's long-term strategy for dealing with Amazon. WMT has been ramping up its "tech" for quite some time to compete with Amazon.

    The retailer has, for instance, started @WalmartLabs, its dot-com headquarters, and has adopted the policies and practices of other Silicon Valley startups, including “treadmill workstations and foosball tables.”

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