Amazon.com, Inc. (NASDAQ:AMZN) has not grown in percentages, but in multiples in the last few years. The company has seen its revenue rising exponentially, riding on the wave of a low price sales boom. By keeping margins razor thin, it has ensured continuous gains in market share while major competitors like Target Corporation (NYSE:TGT) and Best Buy Co., Inc. (NYSE:BBY) are struggling to keep up with the mounting pressure on profit margins.
The stock has not been an exception to the growth story and has grown by over 200% during the last five years and more than 500% when compared with the low of the 2008 recession. The company is optimistic about the future, and so are investors. Quarter after quarter, more and more investment has poured in, showing the belief in the business model which focuses more on creating a highly profitable organization for the future rather than focusing on current margins. Indeed, the operating margins have been shrinking over the years, as can be seen from the following chart.
Mr. Jeff Bezos, CEO of Amazon, however, is extremely confident about the future. In a recent interview, he put forth his opinion about the current condition of the company. According to him, the major index measuring the success of a retail chain company is its free cash flow and not earnings per se. He says that current margins are immaterial as the company is heavily investing in creating infrastructure for the future and that is primarily responsible for the current lack of profitability.
In my opinion, he is only partially correct in this regard. The company has indeed spent billions of dollars in building the so-called fulfillment centers throughout the US, which have the capacity to cater to very high demand, which is forecast in the near future. Also the company has heavily invested in technologies such as the cloud and development of next generation computing devices. These investments are bound to pay off in the future and with high probability will lead to very high cash flow.
But the story does not end here. A major chunk of the profit is eaten away by the free delivery service it offers to its customers. It is literally spending billions of dollars on free delivery which could otherwise have been passed on to the customers, maybe even partially. There is also skepticism over whether the company can continue to grow earnings. Given these situations, it becomes hard to look at the stock as an attractive option to invest when it is already trading with a PE ratio of 3,840, making it an extremely costly investment.
There are other factors as well. The company only operates in seven countries. If it wants to expand its reach to big developing markets such as India and China, it can only do so by creating the complete infrastructure required to deliver products with the same efficiency as it does in the home market. This has a big cost associated with it and is the main reason behind the company’s low international presence. This issue makes it very likely that Amazon will miss the bus of exponential business growth offered by developing countries.
So why is it that even with so many obstacles and a business model that appears to many a recipe for disaster, the stock has continued to grow? To understand this, we need to dig deeper and understand the company philosophy. It is based on faith, faith that some day in the future it will turn more profitable and will finally start to yield to its investors. But in my opinion, this sentiment is not going to last for long, and if the company does not deliver more profit to shareholders soon, the current valuation levels will not last.