When looking at tech and retail giant Amazon.com ($AMZN), several things come to mind.
Not only is it without question one of the best companies of this era, but in Jeff Bezos it has one of the top three visionary CEOs in the entire market. But the stock is expensive by many standards.
With a price-to-earnings ratio of more than 300, investors are betting that the company can execute to perfection. After all, anything less can’t support what its valuation presumes.
On one hand, there aren’t many companies the size of Amazon that is producing the level of growth it has demonstrated.
But as well as it might be performing today in the face of increased competition from Apple ($AAPL), Google ($GOOG) and, on the retail side, Wal-Mart Stores ($WMT), I think it is prudent for investors to wonder whether Amazon can defy gravity forever.
In other words, can it grow into its valuation — metrics that include expectations imposed by the Street regardless of how outrageous they may be?
For example, in its most recent quarter, the company reported 1 cent per share on revenue of $12.83 billion, in line with analysts’ expectations.
However, while revenue soared by almost 30%, earnings per share fell dramatically by 97% year over year. What’s more, over the past five quarters, the company has logged an average of 38.5% revenue growth while net income has dropped by an average of 54% annually during that same span.
In spite of this trend, not only has the stock been up as much as 52% this year but, more impressively, it has surged more than 180% over the past three years. Most stocks would have gotten punished for bottom-line trends of this sort. As much as Wall Street seems to love to complain about valuation, in this case Amazon seems to get a free pass. Why? How long will revenue growth be enough absent meaningful EPS results?
Is Reality Kicking In?
That analysts have started to pare Amazon’s third-quarter estimates should be a welcome sign that perhaps the company can’t defy gravity forever. Current earnings per share estimates (on average) are now at 12 cents vs. the previously anticipated mark of 24 cents. What’s more, over the past three months, the company’s average estimate of $1.36 per share for the current fiscal year has now been trimmed to $1.21.
I think it is time for investors to view the growing pessimism as a sign the company’s investments might take a bit longer to produce the bottom-line growth for which investors are hoping.
Likewise, it’s never a welcome sign that stocks are able to grow in the face of decreasing estimates. In fact, the opposite tends to occur. So essentially, investors still placing bets on Amazon today are assuming the company can continue to defy both gravity and logic at the same time. The odds are not in its favor.
In Wall Street’s insatiable appetite for growth, it is not uncommon for stories such as Amazon to disrupt conventional valuation metrics. That’s all well and good as long as the growth supports its premium pricing. But in Amazon’s case, revenue growth seems to be the only catalyst that matters. That just seems too dangerous absent some important considerations.
Can it sustain its growth in pretax profits as well as improve its gross margins in areas where it has made significant capital investments to compete with Apple, Google and Wal-Mart and now Microsoft ($MSFT)? Amazon’s valuation assumes that at some point its bottom line will reward investors handsomely. But that may not be for another 16 to 24 months.
The length of time the company is able to defy gravity is one thing, but investors have to start wondering how long they should leave their chips on the table before the house does what it always does.
At the time of publication, the author was long AAPL and held no position in any of the other stocks mentioned.
This article was written by an independent contributor, separate from Wall Street Playbook’s regular news coverage.