Josh Blechman

About the Author Josh Blechman

fter graduating from the University of Michigan, I joined ACSI Funds, a Hedge Fund run by Professor Claes Fornell (Donald C. Cook Distinguished Professor Emeritus of Business Administration and the University of Michigan Ross School of Business). Dr. Fornell has devoted his lifes work to the study of customer satisfaction and developed an investment thesis around being able to quantify that intangible asset, in order to take advantage of the enhanced cash flows enjoyed by companies who have satisfied customers. We recently launched an ETF (Ticker: ACSI) based on the same underlying investment thesis. I received an MBA with a specialization in Finance and Real Estate from the NYU Stern School of Business and my current position is Director of Operations and Capital Markets at ACSI Funds., Inc. (AMZN): Looking at the Big Picture, Inc. (NASDAQ:AMZN) reported mixed quarterly results last week, posting a healthy top line beat of $37.95B vs FactSet’s $37.2B consensus, while the bottom line EPS of $0.40 came in significantly lower than the Street’s $1.41 expectation. In light of the sizable earnings miss, some familiar questions are being raised about a deceleration quarterly sales growth rate increase, operating margin pressures and increasing competition in the Amazon Web Services (AWS) space. Additionally, the wide operating income guidance (projecting between -$400 Million and +$300 Million), did little to clarify how management expects Q3 to project. While these concerns have merit, we believe that Amazon is continuing to execute their game-plan, as their strong revenue growth (+25% y/y), justifies their occasional EPS misses. AMZN has historically shown a willingness to spend money and more importantly, the ability to monetize those investments in a way that creates value for their shareholders.

One area of unquestioned success for Amazon is the continued perceived value it delivers to its users, which leads to its overall high customer satisfaction. Amazon was first measured by the American Customer Satisfaction Index (ACSI) in 2000 and has been the highest rated company in the Internet Retail category in 15 of the 17 subsequent years, including the last 10 straight. AMZN is also the largest position in the American Customer Satisfaction Core Alpha ETF (ACSI).

This news should come as no surprise to those who have paid attention to the business ethos of Amazon Founder and CEO Jeff Bezos, who has made it clearthroughout the years that his goal is to “Put the customer at the center of everything we do”. Using that principle as a north star guided Amazon to a meteoric rise in which full-year top line revenue increased +1420% from FY 2006 to the twelve-month period ending 6/30/2017, while its stock price rose +2353% vs +71% for the S&P 500 over that same period.

So, how does customer satisfaction manifest itself in a company’s fundamentals and do we see those traits in AMZN?

The concept of customer satisfaction acting as a leading indicator of stock price has been well established through academic studies from sources ranging from Dr. Claes Fornell (considered the father of customer satisfaction) to the world renown consulting firm McKinsey. Essentially, companies that excel at satisfying their customers are seen to report positive revenue and earnings surprises at a higher than the market rate. An in-depth look at how customer satisfaction works as a financial metric and why it is especially useful in identifying companies who can provide downside protection can be found in this recent article.

The below table shows the percent by which Amazon either beat or missed FactSet’s consensus analyst expectations for revenue, earnings and capital expenditure; as well as the one-day price reaction to those earnings and the total relative performance of AMZN vs the S&P 500 from one reporting period to the next.

According to FactSet’s surprise history database, over the last 4 years, AMZN has posted a top line beat 68.8% of the time (11 of the last 16 quarters) vs a 53.7% beat rate for the total S&P 500 over the same period. However, their EPS positive surprise rate of 62.5% is below the S&P 500 rate of 68.1%. This begs the questions, are these earnings reports consistent with what we would expect to see in a company with excellent customer satisfaction? And should the lower rate of EPS beats concern us?

The important question is not if a company missed on earnings, but why they missed.

The overarching takeaway when looking at the history of Amazon’s earnings reports is that missing on EPS is not necessarily a bad thing, as long as they miss for the right reasons. Amazon has been able to grow their top line sales so aggressively, in part because of their aforementioned singular and relentless focus on the customer. Perhaps better than any other retailer, Amazon delivers an easy and pleasant user experience. In just a few clicks, customers can buy virtually anything they desire and have it arrive reliably within 2 days at no extra charge (for Prime users). At the volume Amazon sells, that seemingly simple process is actually the result of an incredibly sophisticated distribution network, which Amazon has spent many years and many billions of dollars building out. For instance, on its most recent income statement, AMZN spent 13.6% of its total net sales on the fulfilment costs, up from 12.7% in the same quarter last year. It is important to note that four of the six quarters in which AMZN missed on EPS, were accompanied by higher than expected Cap Ex spending. Essentially, we do not view an EPS miss as a negative when it is driven by a company investing in infrastructure that makes the customer experience better.

Given the historical medium-term reaction in AMZN stock price, the market recognizes the positive aspects of this type of EPS miss. The initial price reaction to AMZN earnings over the last 16 quarters has been mixed. In eight of the sixteen relevant reporting periods (50%), AMZN has been down between -2.5% and -11% in the 1 day following the announcement. However, the stock has only underperformed the S&P 500 over the course of the entire quarter, in three of those eight periods (Dec ’13, Jun ’14, Sep ’16). The Amazon story resonates with investors, many of whom are satisfied customers themselves and the stock has historically outperformed the benchmark once the benefits of those heavy investments have had time to be felt by consumers, with the net result of driving sales higher.

Looking to the Future, Short- and Long-Term

The obvious question that Amazon believers and detractors alike have wrestled with is, when will the spending stop? And what good is increasing sales, if spending is so high that profits never follow?

In the short-term, these questions are completely reasonable, especially as it relates to the Q3 guidance in which Amazon has indicated that a substantial Operating Income loss is possible. However, long-term it is important to focus on the nature of these investments; particularly as it relates to infrastructure and the many distribution centers, both domestic and abroad, that Amazon is building. As discussed, the ability to reliably get any product in their catalog to any consumer in the country in two days is central to Amazon’s value proposition and is a major focus of Amazon’s spending.

Infrastructure, with a high fixed cost to variable cost ratio, is inherently sensitive to economies of scale. Amazon may be bent on world retail domination and the infrastructure necessary to accomplish that is vast and incredibly expensive, but it is also finite in that at some point they will have built out the necessary infrastructure to service their market. We do not necessarily see Amazon ever reaching a point where they need to stop spending/innovating. However, in building extreme capacity into their distribution network, as the volume that flows through those centers continues to increase, an increasingly larger percentage will fall to the bottom line. In our view, as long as the company continues to target their investments and focus relentlessly on the customer experience, Amazon will attract the lion’s share of consumers in the new geographical and product markets they enter. This, in turn, will allow for the increased revenue to continue to support infrastructure spending.


As AMZN continues to expand into new product markets (i.e. AWS and groceries) and new geographical markets (i.e. SE Asia and India) additional competition will come, but Amazon is no stranger to competition. It already competes in online retail where the barriers to entry and switching costs are essentially zero. In that type of environment, people will choose to spend their money on platforms that bring them the most utility – or in this case satisfaction. By constantly striving to make their user interface better, their product offerings wider and their delivery quicker; by constantly and relentlessly focusing on what makes life easier for the consumer, Amazon will not only survive the competition, they will thrive in the meritocracy. Essentially, spending at the rate that Amazon does can only be successfully sustained if that spending is directed at the right target. We feel that the potential short term operating losses are a function of Amazon executing its big picture strategy and have conviction in the company’s ability to deliver value to consumers and investors alike in the foreseeable future.


Disclosure:  The author, Josh Blechman, has a position in AMZN. Blechman is the Director of Capital Markets at ACSI Funds, an SEC Registered Investment Advisor. ACSI Funds is the issuer of the American Customer Satisfaction Core Alpha ETF (Ticker: ACSI) All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities and should not be relied on in making any investment decision. All stock price and industry/company financial data was sourced from FactSet unless otherwise noted. Holdings are subject to change and should not be considered a recommendation to buy or sell any security.


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