Why Does Amazon Prefer To Invest In Revenue Growth To Being Profitable?

By Cedric Bollag

Amazon (AMZN) is the biggest online retailer in world and is on track on becoming the most important retailer around the globe. It was founded in Seattle, Washington in 1994 and had Its IPO in July 1995. Its opening price was $16 and currently stands at $312. Jeffrey Bezos is Founder and CEO. Amazon has the biggest online selection in products and is now slowly also moving into offering services. While products range from toys to kitchen supplies and electronics, the services include rentals of Books, DVDs and Music. One of their most popular products is the “Kindle” tablet (more about the Kindle here), which allows you to read an unlimited amount of books every month for just $9.90.

In the next two paragraphs I would like to go into the opportunities and risks of the company to arrive to a final rating and conclusion at the end.

In the latest earnings in July, Amazon presented some impressive numbers. Its revenue is now $9.34b and has a net sales increase of 23% YoY. Furthermore, CEO Jeffery Bezos claims that their new service package “Prime” is the product with the most “precision and attention to detail ever seen for retail purchases and is currently being used by ten million customers” (more about Prime here). Amazon’s vision is to drastically expand their percentage of service of total revenue to assure high customer retention and simultaneously to assure that people keep using their site for retail shopping. This can be nicely seen in the presented chart, as the service percentage increased from 9% of total revenue in 2009 to 18% in 2013 (see Graph). One of their greatest opportunities is the release of their first smartphone called “Fire”, which has some very interesting new features, not seen yet in any of their competitors and it integrates the entire shopping experience into a mobile experience and makes it very easy and intuitive to shop and use the services of Amazon. One of the biggest accounting advantages Amazon has is the fact that they can keep their direct overhead cost very low, which means they can save on their overall cost and show higher earnings. According to Amazon customer reviews the page is significantly more convenient, has better price comparison and a bigger variety of selection than the competitors.

When looking at the companies risk, we can see that there are some milestones for the company to over come. Slowly but surely other companies understood the many advantages of developing a gadget like the Kindle and offer services for it, meaning there are more and more competitors out there who also offer a handheld device for book reading. One of the old and traditional risks of retailers is the inventory. Amazon uses top nudge technology to assure that they operate at a perfect inventory level. This is a very tough game and hence part of the risk Amazon is facing, while offering so many different products. As mentioned already earlier, Amazon’s reinvestment rate is very high. Most of their profit is invested in the company’s growth, which means that the company’s operating loss of $126m is very unnecessary and this worries stockholders. Conclusive we can say that Amazon has very high revenues, a very high re-investment rate and an uneven profitability.

Michael Pachter, Analyst at Wedbush, gave the stock a Hold rating with a price target of $330 (currently $312) with the reasoning of having “little confidence in Amazon management’s desire to provide investors with a road map for the company’s strategy”. I believe that this stock is worth a Buy rating for long-term investors but for short-term investors it might be not of relevance at the moment. Investors in general have little confidence in the management providing a clear strategy for how the shareholders can make a nice return on their investment. This is called taking a “leap-of-faith” on the stock. One of the greatest dilemmas every publicly traded company has is whether to focus on maximizing shareholder value versus company growth. Amazon focuses very much on its growth in the very costly and slow-earning-power service sector, which is often criticized by the shareholders, who prefer a stock appreciation.

According to TipRanks.com, which measures analysts’ and bloggers’ success rate based on how their calls perform, analyst Michael Pachter has a total average return of 0.1% and a 47.3% success rate. Pachter is ranked #2263 out of 3243 analysts.

Conclusive I can say it’s definitely one of the stocks to watch in the future. For short-term (up to one year) investors it’s a Hold, while for long-term (more than one year) investors I would rate it as a Buy.

AMZN Chart