Let's describe the perfect stock. This company would have cost advantages over the competition, so it could beat them on pricing, and yet still make money. It would show strong, accelerating revenue growth, with their newest businesses growing the fastest. Last but not least, earnings estimates would be increasing, and the company would beat current estimates on a consistent basis. If this sounds like the perfect stock, Amazon (NASDAQ:AMZN) investors should know that few of these statements describe their company.
Huge Revenue Growth Is The Reason The Company Is A Buy...Nope
Many Amazon investors would suggest that the company's huge revenue growth is a prime reason to buy the stock. Unfortunately, this first delusion about Amazon is deeply ingrained, and the truth is that the company's revenue growth is slowing down.
If you look at Amazon's quarterly report, the company does investors the favor of including five quarters of results to give some historical perspective. The bad news is that Amazon's current quarter 22% revenue growth was the slowest of the last five quarters. It's easy to say that their revenue growth is trouncing Barnes & Noble (NYSE:BKS) and Best Buy (NYSE:BBY). However, both of these companies are suffering from negative revenue growth, and the comparison is a bit unfair. But to suggest that Amazon is outperforming eBay (NASDAQ:EBAY) is something else entirely.
Since eBay doesn't sell goods and services directly, looking at the amount of e-commerce eBay helps to enable is a more fair comparison to Amazon's revenue growth. eBay reported total e-commerce enabled grew by 21% on a year-over-year basis. Given that Amazon grew revenue by 22%, you can see these two Internet titans are more closely matched than some realize.
Amazon Will Not Transition Away From General Merchandise Sales
The third delusion many Amazon investors suffer from is the assumption that as Amazon enters new businesses, their general merchandise sales will become less important. While that might occur at some point, that point is not today.
In the company's most recent quarter, 66.32% of the company's overall revenue was from electronics and general merchandise. Last year, electronics and general merchandise sales were as low as 61.99% of total revenue. However, in the last three quarters the company generated between 63% and 66% of revenue from this category. Though digital media, web hosting, and other ventures may become important someday, Amazon is still primarily a general retailer.
When The Spending Stops, Earnings Will Not Explode
The idea that Amazon can reach a maximum level of spending on technology and fulfillment is the fourth delusion about the company. Amazon's gross margin may get the headlines, but their operating margin tells a more interesting story. In the current quarter, Amazon's operating margin was just 2.6%.
When you compare this to eBay's margin of 19.34%, you can see eBay's built-in advantage pretty clearly. Given Best Buy's struggles, it's somewhat surprising that they managed an operating margin of 1.8% in the current quarter. Barnes & Noble reported a negative operating margin, but due to huge changes in the NOOK business model , the company expects to improve this measure going forward.
Amazon's spending on technology and fulfillment expenses seems to be increasing constantly. The company's technology expenses increased from 8.43% of revenue to 10.10% in the last year. Amazon is in a constant fight for content with Netflix, so investors shouldn't expect this expense to decline in the near future.
While fulfillment expenses may slow in the future, each new warehouse brings fixed costs like a lease or mortgage payment, utilities, payroll and benefits, and more. Increased fulfillment expenses make Amazon sound vaguely like a physical retailer.
Amazon Shouldn't Beat Earnings Estimates
If investors think Amazon will beat estimates, they are suffering from the fifth and worst delusion of all. In the last four quarters, the company has missed estimates three times, and overall has missed by an average of 172.5% .
In response to this performance, analysts have lowered estimates for the third and fourth quarter, and full year estimates for 2013 and 2014 have come down as well. By comparison, in the last four quarters eBay beat estimates three times, and missed once, by an average of 0.83%. Best Buy beat estimates three times and missed once, by an average of 32.15%. Though Barnes & Noble is clearly struggling, the company outperformed Amazon by this measure, beating estimates twice, and missing twice, for an average miss of 44.6%.
You Can't Buy This
For investors buying into all of the above five delusions, they are paying over 330 times projected earnings for this full year. For a company that analysts expect to grow earnings by about 36% in the next few years, this is a steep price to pay.
Given the choice between buying Barnes & Noble with negative expected earnings and negative EPS growth, I guess the Amazon story sounds OK. Considering that investors can buy Best Buy for about 14 times projected earnings, and get a 2.2% yield and expected EPS growth of 6.7%, it might be tough for growth investors to ignore Amazon.
However, when you realize that eBay is enabling almost as much commerce as Amazon, yet sells for a forward P/E of just over 19, the case for Amazon falls apart. eBay reported double digit growth in users at both PayPal and its Marketplaces businesses. The company has a much higher operating margin than Amazon, and generates substantial free cash flow (over $650 million last quarter). Given these numbers from eBay, buying Amazon at these levels just seems like a bad call.