Amazon.com Inc (AMZN): Don’t Pay Tomorrow’s Price Today

Amazon.com, Inc. (NASDAQ:AMZN) is a company which seems to draw strong opinions from both sides. Some claim that Amazon is grossly overvalued with terrible margins and an inability to generate substantial profits. Others claim that Amazon is simply heavily investing in its future and that the company could make huge profits if it wanted to. They say revenue is the number to care about, not profits.

The problem with Amazon is that you’re paying tomorrow’s price today for the stock. As of the end of the third quarter of 2012 TTM revenue stood at $57.26 billion. COGS ate up $43.67 billion of this, or 76.3%, while operating expenses ate up another $13.06 billion, or 22.8%. These percentages for COGS and operating expenses have remained roughly the same over the past decade. This leaves an operating income (before interest and taxes) of $531 million, or just 0.93% of revenue. Net income came in at a paltry $40 million, or 0.07% of revenue.

Free cash flow has looked a bit better. In the TTM period FCF was $1.06 billion, down from $2.09 billion in 2011. The average FCF in the 5-year period ending in 2011 was $2.01 billion, or 3.5% of the TTM revenue.

What has seen tremendous growth is Amazon’s revenue. Over the last decade revenue has grown at an annualized rate of 28.4%. The 5-year annualized growth rate is slightly lower at 26.5%. Both COGS and operating expenses as a percentage of revenue have risen at about the same rate.

The current stock price is $267.94 per share with a total diluted share count of 461 million, resulting in a market capitalization of $123.5 billion. Let’s calculate some TTM ratios:

Data from Morningstar

These numbers look pretty terrible. An interesting point is that Amazon.com, Inc. (NASDAQ:AMZN) trades at 9x gross profit. For comparison, Apple Inc. (NASDAQ:AAPL), another company which has seen the same kind of incredible revenue growth, was trading at about 10x gross profit at the end fiscal 2012 (this was right around Apple’s all time high of $700 per share). The difference, of course, is that Apple was also trading at about 14-15 times FCF as opposed to Amazon’s 116. In other words, Apple generates incredible profits while Amazon does not. Why, then, does the market not care about Amazon’s profits? If Apple were valued at the same P/FCF ratio as Amazon it would have a market cap of $4.8 trillion! That’s trillion, with a ‘T’.