Introduction
Amazon: the Valuation Dark Side
It is no secret that Amazon (AMZN) has been a disruptive force, especially relating to the retail sector. On the other hand, the company is also an enigma to the value focused fundamental investor such as yours truly. Over its entire operating history as a publicly traded company, Amazon has commanded what can only be called stratospheric earnings multiples (P/E ratios). Whether you’re looking at trailing twelve month (ttm) earnings, forward earnings or a blend of the two, Amazon’s P/E ratio is typically reported at more than 100 times earnings.
This seems bizarre because from a profitability point of view, Amazon looks like a real dud. Their gross profit margins have historically come in above 20%, and for 2016 their gross profit margin exceeded 35%. However, net profit margins are a different story entirely. When they do generate a net profit margin, which they only occasionally do, it is typically razor thin. Furthermore, Amazon has often generated large negative net profit margins. Therefore, the primary reason why their P/E ratios are so high is because they produce very little in the way of earnings (E).
Amazon: The Fairly Valued Perspective
On the other hand, Amazon’s revenue growth has been nothing short of extraordinary. The same can be said for Amazon’s prodigious operating cash flow growth, and the company does report a lot of free cash flow, although there is some controversy related to how Amazon reports free cash flow. Here is an article written by Seeking Alpha author who goes by Slim Shady that debates the authenticity of how Amazon reports free cash flow.
Nevertheless, even though the company generates significant cash flows, its record of returning cash to investors would have to be given a resounding F or failing grade. Amazon is a growth stock, and as such, pays no dividend so there is no cash returned in this traditional sense. Additionally, Amazon does not buy back shares; instead, they have increased their share count by approximately 5% per annum since 1996.
However, the point that Amazon is a growth stock should not be taken lightly. A true growth stock like Amazon requires capital investment to fund their growth. Therefore, it’s quite typical that a growth stock does not pay a dividend. Instead of paying a dividend, growth stocks like Amazon utilize every bit of capital at their disposal to continue funding future growth. This also speaks to the reason why Amazon raises capital by issuing additional shares. As an aside, Amazon also generously utilizes their shares to compensate employees of the company. Nevertheless, as far as growth stocks go, Amazon, led by Jeff Bezos, could arguably be called the most growth hungry company in history.
But perhaps most importantly as it relates to this article, this growth hungry corporate culture speaks to Amazon’s lack of profitability. Jeff Bezos has clearly been content and willing to forgo profits in favor of achieving rapid growth. Nevertheless, even though Amazon is light on profitability, the company’s revenue and reported operating cash flow growth have indisputably created enormous shareholder value. Consequently, I suggest that Amazon actually appears fairly valued when shares are viewed from the perspective of operating cash flow and operating cash flow growth.
