Smart Amazon Fan: But He Ignores Valuation

Eugene Wei weighs in, again, about his former employer, Amazon (AMZN), a company he seems truly devoted to.

Like a lot of tech people, Wei seems also to want to be a media critic, and he spends some time discussing coverage he feels is wrongheaded. I’m sure much of YCharts’ Amazon coverage would fall into that category if Wei had a look at it.

Wei talks smartly -- though, as he notes, with Amazon’s opaque financial statements, it’s hard to understand, from the outside, how its various businesses are actually performing -- about Founder/CEO Jeff Bezos’s approach. (Investment research tools, sadly, work better when they have specific and relevant hard data to manipulate.) Like all Amazon fans, Wei reminds us that Bezos is playing for the long-term, a designation that seems virtuous to many since American business is so often criticized (justifiably) for being too short-term oriented, particularly publicly-traded companies and the matter of making their projected quarterly results.

My boiling down of Wei: lots of Amazon business is already quite profitable; the profits are being reinvested in newer businesses because Bezos wants to rule the retail world; lazy journalists focus on profits and margins when they ought to pay attention to free cash flow (Bezos likewise likes to talk about cash flow); a company that doesn’t need to be profitable just now ought to really scare the competition (No shit, Eugene. Picking retail stocks alongside Amazon is an exercise is gauging vulnerability and resistance to Amazon's business model.)

Wei calls Amazon a fixed-cost business and discusses the huge investment in warehouses, noting that when sales hit a certain level those costs are covered and profits roll in. True, as far as it goes. But Amazon also has enormous variable costs. Like employees. And the worker count has been rising faster than sales, at least by this crude count. (Granted, the number of total workers does not equal payroll.)

AMZN Gross PP&E (Annual) Chart

AMZN Gross PP&E (Annual) data by YCharts

That gets you a decline in revenue per employee, which seems a decent, if rough, metric to look at.

AMZN Revenue Per Employee (Annual) Chart

AMZN Revenue Per Employee (Annual) data by YCharts

While the investment binge might be to satisfy tomorrow’s demand, the hiring binge, it says here, is mostly to satisfy today’s sales. Yes, yes, we know Amazon bought a robot company and has been deploying hundreds of them. Bully. But its business remains labor-intensive, as in human labor; which is why, on top of the huge permanent payroll, the company is hiring 70,000 seasonal workers for the holiday rush.

Wei states:

“I'm convinced Amazon could easily turn a quarterly profit now. Many times in its history, it could have been content to stop investing in new product lines, new fulfillment centers, new countries. The fixed cost base would flatten out, its sales would continue growing for some period of time and then flatten out, and it would harvest some annuity of profits.”

He’s no doubt right. But this and much of his entire piece side-steps for investors what is the crucial question: does today’s valuation of Amazon correctly reflect its future performance? I have no doubt Amazon will turn profitable at some point, but to do so may very well require it to forsake growth. And growth is what has powered the stock to such highs.

AMZN Chart

AMZN data by YCharts

Has investing for the future narrowed Amazon’s margins in recent years, or are those marginal sales more expensive to come by, requiring free shipping and other price slashing to keep revenue rising? Is profitless growth really Bezos’ choice, or is it the only option left to him by the stock market – since investors clearly focus on revenue growth and not profits? A cynic could conclude that Bezos & Co. are being led by the market, rather than the other way around. Running his company absent its spectacular and rising market cap – which allows Bezos to hand out stock options and thus pay his people less cash – would really be expensive.

AMZN PS Ratio (TTM) Chart

AMZN PS Ratio (TTM) data by YCharts

Mature retailers – Amazon will inevitably become one – trade at considerably lower price-to-sales ratios, of course. Perhaps Amazon’s future margins will justify a higher ratio even when its growth slows. Amazon offers amazing services. It’s probably going to be a great business (as in profitable). Valuing its stock is another matter.

Jeff Bailey, The Editor of YCharts, is a former reporter, editor and columnist at the Wall Street Journal and New York Times. He can be reached at Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.



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