Today's Opinions, Tomorrow's Reality 

Foolish Investment

By David G. Young

Washington, DC, July 15, 2014 --  

Amazon's long-term growth might be better than short-term profits, but only if those profits eventually come.

When Amazon posted a $126 million quarterly loss and warned of bigger losses to come1, it did so one day before launching the Fire phone -- the company's first entry into the mobile phone market.

Coincidence?  Not exactly.  Instead of passing on its massive revenue to shareholders as profits, Amazon is engaging of massive spending (this quarter spending even more than it takes in) not just on operating costs, but enormous investments into new infrastructure and new products.  The Fire phone is the most high profile of these new products this year.

A dip in Amazon's share price after the disappointing earnings results were announced was widely reported as evidence that investors are tiring of Amazon's strategy of sacrificing short-term profit for growth, and are losing confidence that consistent profits will ever come.  But even after markets closed Friday, Amazon was still trading at a stratospheric P/E ratio of 8513, making the stock cost 60 times more for expected earnings than the market's historical average.  Clearly, shareholders must expect some incredibly gigantic profits in the future, or at least some enormous growth in the size of the company.

High growth expectations are common for small companies and even amongst bigger technology companies, which seek to invest revenue into new areas to foster further growth.  What makes Amazon stand out from its growth stock peers is its sheer size.  It's no startup.  It's not even comparable to most Silicon Valley growth companies.  Amazon is huge by any measure.  It has a $150 billion market capitalization (about the same as banking giant Citigroup) and quarterly revenue of $20 billion (about the same as Ford Motor Company)2  Yet is not making money.  At this phase in a company's life, this is highly unusual.

Once companies get as big as Amazon, innovation typically wanes as conservatism and institutional momentum set in.  Silicon Valley companies can be an exception to this rule.  Amazon's peers at Google and Apple remain quite innovative despite being even larger than Amazon.  But these companies differ from Amazon in that they produce both steady profits and innovation simultaneously.  Although some of this innovation risks being wasteful science projects -- will Google's self-driving cars really ever make the company any money?

The risk of big, foolish investments is exactly what Amazon shareholders face.  The company's new Fire phone venture has been criticized on multiple fronts.  It is too expensive.  It runs a hobbled fork of the Android operating system.  It is available on only one American mobile carrier.  Its stand-out features are all gimmicks.  Is it a smart investment for the future? Is it an expensive vanity project? A case of throwing spaghetti against the wall to see what sticks?

Yes, the phone could push people to buy more stuff at Amazon.  But that stuff doesn't make the company much money because of razor-thin margins.  And meanwhile, Amazon's more profitable operations, like its Amazon Web Services business (which supplies computing infrastructure to other companies), has been undercut by aggressive price competition from rivals at Google, Microsoft and Apple. The most recent earnings report showed that growth of this profitable business line has begun to slow.4

Clearly, those who believe in the future of Amazon have faith in CEO Jeff Bezos' vision in investments that will ultimately pay off.  And maybe they will.  But given the company's tight-lipped of sharing its internal investments and corporate strategy, investors would be wise to be a little more skeptical.  Yes, companies like Apple are even more tight-lipped.  But Apple delivers profits and Amazon does not.  Investors will one day discover whether these investments are wise -- by learning whether consistent profits ever actually come.


1. Wall Street Journal, Amazon Reports Loss Despite Strong Sales Growth, July 25, 2014

2. New York Times, Ford Reports Earnings of 1.3 Billion, July 24, 2014

3. Google Finance, Amazon, as posted July 26, 2014

4. Bloomberg Businessweek, Amazon's Slowing Cloud and Other Hidden Measures of Its Health, July 24, 2014