When will Amazon fall down?

Investors remain confident in Bezos' ability to deliver profits.

By TheStreet Staff Nov 1, 2012 2:55PM

thestreet.com logoBy Richard Saintvilus  

 

I asked recently if e-commerce giant Amazon (AMZNcan keep defying gravity as it pushes further into territories dominated by tech giants Apple (AAPL) and Google (GOOG). The premise continues to be the same -- how long will investors pay such incredible premiums for revenue growth in absence of meaningful profits? Following Amazon's third quarter earnings report, this question was answered -- albeit not entirely.

 
There is no denying that Amazon has been an incredible story. The level of growth the company consistently demonstrates is nothing short of remarkable -- particularly considering its size.
 
But with a price-to-earnings ratio of over 300, Amazon needs to execute flawlessly for the stock to make sense. This quarter was anything but perfect.

 

For the third quarter, Amazon did what everyone expected it to do in terms of revenue, as sales soared 27% to $13.81 billion -- beating its own estimates of $12.89 billion. Remarkably, over the past five quarters, revenue has increased by an average of 34%. The company's challenge however remains profit growth, which again fell short of analysts' estimates.

 

Although Amazon rarely issues earnings projections, it reported a net loss of 60 cents per share -- much lower than analysts' estimates of 8 cents per share. Disappointingly, during the third quarter, the company swung to a loss of $274 million after the prior three quarters yielded profits. On the other hand, by reporting an operating loss of (only) $28 million, the company did exceed its own guidance for operating income of a loss between $50 million and $350 million.

 

For the coming quarter, things are not expected to immediately turn around. Amazon expects revenue to arrive between $20.25 billion and $22.75 billion. As noted, the company does not provided EPS guidance. However, consensus estimates are at 50 cents per share, which has come down from 68 cents over the past three months.

 
Moving forward

 

During the announcement, Jeff Bezos, Amazon's founder and CEO said:

 

"Our approach is to work hard to charge less. Sell devices near breakeven and you can pack a lot of sophisticated hardware into a very low price point. And our approach is working."

 

It's hard to disagree with Bezos on his assessment of the company's model -- especially, seeing what Amazon has been able to accomplish over the past decade. The company is without question one of the best success stories of this era. Likewise, Bezos ranks up there with Steve Jobs as one of the top visionary CEOs of all time. But the stock is expensive. This has been my biggest concern over the past couple of years.

 

That said, I am fully aware it is not uncommon for the market to care very little about valuation metrics when a company such as Amazon is producing growth in excess of 30%. But what happens when it stops? Earnings will start to matter. As disappointing as this quarter was in terms of profitability, it followed the second quarter during which EPS fell dramatically by 97% year-over-year.

 

That the stock still surged post the announcement suggests that investors don't care and instead continue to salivate over the company's top-line growth. But that growth is coming at an incredible cost as evident by the 42% increase in operating expenses. Consequently, operating margins declined by 93 basis points. The company has answered questions of whether its growing expenses can produce sales. But will these investments ever pay off by way of profits?

 
Bottom line
 

That the stock is up over 50% on the year and almost 200% over the past three years speaks to the confidence that investors have in the company's ability to deliver on its promise. But Amazon cannot rest easily. Apple, Google and now Microsoft (MSFT) have their own plans for acquiring market share. What's more, I continue to wonder if Amazon will be able to sustain its growth in pre-tax profits as well as improve its gross margins in areas where it has invested so heavily.

 

So far the company has answered several of its critics that have wondered can it grow into its valuation. In the meantime, investors continue to bet heavily that Amazon's growth will maintain its torrid pace -- even if it means sacrificing near-term profits. But with the company having acquired a P/E ratio that have soared to nose bleed levels, for investors' sake, let's hope the words "sacrifice" and "bleed" are never used together to answer future questions regarding Amazon.

 

 

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