Amazon: Everything Grows But the Profit Margin

Stocks of companies that provide a great service and that revolutionize an industry tend to attract fanatical followings, and that is at least partial explanation for Amazon’s (AMZN) incredible valuation. The market cap is huge.

Amazon.com Stock Chart

Profits aren’t so huge, so Amazon has a p/e ratio of about 70, based on trailing earnings. That multiple is considerably higher than Amazon’s growth rate.

Amazon.com Stock Chart

Another reason for the stock’s lofty price is Amazon’s top-line growth. But, as YCharts has noted in the past, though Amazon may have spectacular revenue growth, its darned expenses rise in lockstep, book for book, Kindle for Kindle, as if Jeff Bezos’s company just can’t get any more efficient.

Amazon.com Stock Chart

That leaves the online retailer with roughly the same razor thin margins found at other, less sexy discount retailers.

AMZN, WMT, TGT Chart

As it maximizes use of its warehouses and computer systems, one might expect Amazon’s margins to widen. But for the first three quarters of 2010, a 42% increase in sales brought just a 42% increase in net income, and per-share results rose only 37% due to a rise in shares outstanding.

For this year’s fourth quarter, Amazon is projecting a sales increase of between 26% and 40%, yet it says operating income should be in a range between a 24% decline and an 18% increase. That’s hardly the sort of leverage one looks for in a growing company – compressed margins in the company’s biggest quarter to date.

One problem is all that free postage. Net shipping costs – what Amazon pays to ship stuff minus the amount it collects from customers who pay for shipping – rose to 3.9% of sales during the first three quarters of this year, up from 3.3% a year earlier. Good deal for the customers.

And now comes word that the state of Texas in September sent Amazon a $269 million bill for uncollected sales taxes between December 2005 and December 2009. Favorable Supreme Court rulings have exempted much online commerce from sales taxes, but some states have been exploring ways around the rulings. Giving Internet start-ups a tax break seemed the patriotic thing to do a decade ago. But now that states and municipalities are in financial trouble – and buying a best seller online seems mundane – why let this growing distribution channel skate on taxes, government bosses wonder?

Adding sales taxes would bump up Amazon prices substantially, and make it less competitive than it is now. Sales tax in almost every state is higher than Amazon’s after-tax margin of about 3.5%.

The YCharts proprietary investment model finds Amazon’s shares to be significantly overvalued. More so than it did nearly a year ago.

Amazon.com Stock Chart

And Amazon may be the rare company that realizes its stock is no bargain: it hasn’t bought back any stock last year or during the first three quarters of 2010. And when acquiring Zappos for about $850 million last year, Amazon paid almost entirely with its pricey stock.