Death and taxes. Those are the surefire things in life. Oh and Amazon.com, Inc. (NASDAQ:AMZN)‘s minuscule profits, too. Quarter in and quarter out, it seems like it’s the same old story: Jeff Bezos and company make billions in revenue with nothing to show for it. At least that’s how many view it. And to an extent, I get it. I mean, P/E ratios tell the whole story, right? Wrong.
Where the money isn’t
One of the general themes of recent earnings seasons has been top-line organic revenue growth (or the lack thereof). Many companies have done a great job of controlling costs in order to keep earnings growth alive, but revenue growth has been less than stellar, thanks to a sluggish global economy. Just look at McDonald’s Corporation (NYSE:MCD). Sales since 2011 have been utterly flat, and while earnings per share have grown about 3.5%, cost-cutting can only get you so far.
Amazon.com, Inc. (NASDAQ:AMZN), on the other hand, is growing the top line like they have a bet to win. Sales are up almost 38% since 2011 and, if we look back a full five years, sales have grown at a whopping 29.5% compound annual growth rate. That’s not too shabby for a sluggish economy coming out of recession. Of course, that’s not the number that most people focus on when it comes to Amazon.com, Inc. (NASDAQ:AMZN). It’s net income that has everybody’s knickers in a knot. How can a company that makes so much revenue be so unprofitable? And why in the world are we paying 800 times earnings for it?
You say yes, I say no
Investing, at its core, is disagreeing isn’t it? For every buyer there’s a seller, and both parties happen to think they’re right. With that said, I’ll submit that I don’t believe valuing Amazon.com, Inc. (NASDAQ:AMZN) based on net income is the best way to look at it. I know, I know… plenty of Amazon bears out there want to throw a pie at my face when I say this. But it’s just for perspective, so follow me for a second.
Amazon.com, Inc. (NASDAQ:AMZN)’s business model operates with what’s known as a negative cash conversion cycle. What this means in English is that Amazon gets paid for what it sells to customers like you and me well before they ever have to actually pay for it itself. This is important because the net income number doesn’t reflect the advantages of a negative cash conversion cycle; but the cash flow from operations (CFFO) number on the cash flow statement does. It adds back those accounts payable as if it’s cash that hasn’t flowed out of the business, yet it’s cash that Amazon.com, Inc. (NASDAQ:AMZN) can use to reinvest to grow the business.
It’s all about the cash flow
So it becomes a bit more clear why in their earnings calls, Amazon management reiterates time and time again that they are not focused on earnings, they are focused on cash flow; both operating and free.