Amazon is red hot thanks to Kindle Fire

The stock pops as much as 17% after strong earnings and a 'short squeeze.'

By InvestorPlace Apr 27, 2012 10:06AM

By Tom Taulli

Ahead of Amazon's (AMZN) first-quarter report, investors were glum. Shares had fallen from almost $230 in October to under $190 in mid-April on fears that the company was spending way too much on subsidizing its Kindle Fire tablet and wouldn't have the sales to make up the difference.

Turned out there was nothing to worry about, as the company handily beat the consensus on revenue and profit. In early trading Friday, the stock was up 17% to $230 -- largely because short sellers betting against AMZN were proved very wrong and raced to cover their trades.

First let's talk earnings. For the quarter, net income was $130 million, or 28 cents per share, on net sales of $13.18 billion. While that was down from last year's first-quarter earnings -- which came to 44 cents per share -- it was much better than expected. The Street had forecast only 7 cents a share on revenue of $12.90 billion.

That spooked short sellers, who sell shares first and then have to "cover" their positions later by buying back the same amount of a given stock. The idea is if you sell a stock at $200 and then buy it back at $150 a month or two later, you make $50 a share.

Unfortunately if that stock rises, you lose money. And the rush of short sellers buying back shares only sends a given stock's price higher -- which is part of the reason Amazon kept going up and up and up after earnings.

Sure, some buyers were undoubtedly folks who had confidence in the long-term potential of the stock. But many were also short sellers who had to cover their trades. Better to take your lumps and buy back AMZN at $225 today than at $250 or $300 several weeks from now.

The so-called short squeeze was in play, but that shouldn't overshadow the strength of Amazon and its impressive results that validate the company's strategy. Amazon continued to spend aggressively to bolster growth. Costs for fulfillment were $1.3 billion in the quarter, up from $855 million in the same period a year ago. Technology and content also rose from $579 million to $945 million.

In fact, Amazon plunked down $775 billion for Kiva Systems, which is a top provider of robots for distribution warehouses. It should help bring about lower costs, at least over time.

The only thing iffy was that the company's guidance for the second quarter looks a bit light. Revenue is expected to grow between 20% to 34%. Of course, that may be an attempt to set the bar low.

The Kindle Fire has become a big driver of Amazon, without a doubt. According to a report from comScore, the device has seen its Google (GOOG) Android market share go from 29.4% in December to 54.4% in February.

The Kindle Fire is really critical for Amazon. It's a way to help blunt the onslaught of Apple's (AAPL) iPad tablet. Apple got its mojo back with strong earnings earlier in the week, and Amazon will need everything it has to take on the gadget giant.

The Kindle can also help Amazon deal with eBay (EBAY), which is getting lots of traction with its mobile business.

To help create even more stickiness, Amazon has also been making more of its content exclusive, with 130,000 titles available only on its site.

No doubt, Amazon wants to remake the retail landscape. This means disrupting not only traditional retailers like Best Buy (BBY) and Wal-Mart (WMT) but also industries like publishing and even Web services (Amazon is one of the largest cloud providers). To pull this off, it's willing to sacrifice operating margins, which were only 1.5% in Q1.

It's a gutsy strategy, but it's necessary to keep up the growth momentum. Yet investors should be cautious. The stock's rise looks overdone and is partially the result of a short squeeze. And with Amazon's price-earnings ratio north of 180, investors who see better days coming may want to wait before picking up shares.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.

Related Articles:

Apr 27, 2012 10:23AM
Apr 27, 2012 12:13PM
That can't be the Kiva where we loan money to needy throughout the world !  
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