Source: Amazon.com.
E-commerce pioneer Amazon.com (AMZN +1.10%) soared last month, continuing the heated debate among many investors about the stock's long-term upward path. For those who profess to follow value principles, Amazon remains an enigma, as its earnings multiples have never approached levels that most value investors would consider attractive. Yet even with its net-income handicap, Amazon's revenue growth rates have proven its success in becoming a dominant player in online retail as well as a major competitor in the budding cloud-computing segment. As the holiday season kicks into high gear, shareholders firmly expect that Amazon will be able to do better than some of its previous guidance would suggest. Let's take a closer look at how Amazon bounced back from a tough October and whether investors should expect further gains to come.
How Amazon got its groove back
Coming into last month, Amazon had just disappointed shareholders with a tough third-quarter earnings report. Revenue come in weaker than expected, and Amazon posted a per-share net loss that was more than $0.20 worse than investors were looking to see. Amazon's guidance scared investors even more, with the company predicting sales growth for the holiday quarter of between 7% and 18%, well below the 20% gain in revenue that Amazon pulled in last year. At a time when markets were already turbulent, investors didn't have much patience with Amazon's uncertain future.
Yet as has happened repeatedly in the past, investors got past the dire-looking GAAP earnings picture to focus on measures where Amazon fares much better. On a cash-flow basis, Amazon has generated substantial amounts of money for a long time, and that even incorporates the huge sums of money Amazon has spent on innovative initiatives designed to expand its reach and bolster the size of its budding ecosystem. Not all of those initiatives have been successful, as the recent flop of the Amazon Fire Phone showed. Still, by looking to reach as many customers as possible, Amazon can position itself to make even more money in the long run once it comes closer to reaching its full potential.
Amazon Fire. Source: Amazon.
New announcements also helped generate some enthusiasm about Amazon. Last month, Amazon announced new features for its landmark Kindle e-readers, as well as beginning to ship its Fire TV Stick product and releasing its Amazon Echo service. Although the reception wasn't entirely positive, some investors nevertheless took the events as a catalyst to drive Amazon stock higher.
Should Amazon investors really celebrate?
From a longer-term perspective, Amazon investors need to understand that despite the highly visible presence of the Amazon.com website, the company doesn't see e-commerce as its most promising segment going forward. Rather, Amazon has ambitious plans to expand its presence in the cloud-computing space, establishing data centers across the globe in an effort to take greater control of the technology infrastructure. Even though the company has focused mostly on price-based competition with its Amazon Web Services division, Amazon nevertheless can expect better long-term margins from its technology division than it gets from retail, and that makes its current strategy make sense from a profit standpoint.
There's no doubt, though, that Amazon faces plenty of obstacles in its path. Retail rivals have started to borrow pages from Amazon's playbook, using algorithms and other strategies to compete better with the premier e-commerce giant on price. Moreover, now that Amazon has started to collect sales tax in a rising number of states, it no longer enjoys the cost advantage that it used to have against traditional retailers with brick-and-mortar operations. Meanwhile, on the cloud side of the business, Google (GOOG +2.80%)(GOOGL +3.41%) and Microsoft (MSFT 0.24%) both have pushed hard to claim their share of potential cloud-based revenue.
Nevertheless, what bullish investors have focused on lately is the fact that Amazon has already done a great job of building up a loyal customer base. By hinging free shipping on its membership-based Amazon Prime service, Amazon gave customers an incentive to become more connected to its ecosystem, and the company has subsequently used Prime as a stepping stone to offer even more new services. By taking a page from Costco (COST +0.01%) and its own business model based on high-margin membership revenue, Amazon hopes it can hold off Google and other competitors while sustaining its reputation as the go-to e-commerce retailer in the business.
Amazon's gains in November helped reestablish some confidence in the stock, but even with its rebound, Amazon shares remain about 20% below their highs from earlier in the year. Until Amazon can demonstrate that its long-term growth trend isn't slowing too quickly, shareholders will be reticent about showing too much enthusiasm about whether shares can bounce all the way back to all-time record highs.
