Amazon’s Uh-Oh Moment Looming?

YCharts

Amazon.com (AMZN) is suddenly facing its most serious competition ever, funded by heavyweights like eBay (EBAY) and Google (GOOG) aiming to snatch away its most profitable business. Amazon investors, most of whom have huge profits that could be taken, might ask: are Amazon shares, see here in a stock chart, finally headed for a correction?

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AMZN Chart

Amazon investors likely would lose some of those beautiful gains if the stock started trading like a normal growth company. It hasn’t yet. Amazon has given investors amazing returns – it trades about 260% higher than its price five years ago – even though profits, free cash flow, operating margins and revenue growth rates have gone down. Meanwhile, its PE ratio remains in almost incalculable territory that is rarely plowed by a company with $61.09 billion in annual revenues and a $120.71 market cap.

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AMZN Free Cash Flow TTM Chart

It’s a set-up for a correction in a lesser company, but Amazon has proven itself an exception to the rules again and again. Fourth quarter earnings results released January 29 missed profit and revenue forecasts and revealed only razor-thin profit margins. The net loss for the year totaled $39 million. Management offered rather unsatisfying first quarter guidance that said the company could lose as much as $285 million or earn as much as $65 million. They forecast revenue growth at about 24%, which would be slightly lower than last year. The share price rose anyway.

Amazon attracts investors because it is a giant in several fast-growing industries, including video streaming, music and book downloads, e-readers and tablets, and e-commerce generally. Investors give it a pass on profitability because they believe that these markets are so big that Amazon can still grow a lot more, despite its age and size. Forecasters call for sales to double in five years and profits to rise by about 1,000%.

But a couple of things have happened since those 4Q numbers that threaten to bite what little profits Amazon creates. eBay announced big plans to lure Amazon Marketplace sellers to its site with lower fees. That kind of hit would hurt. Marketplace, where sellers pay Amazon to sell their stuff, is one of its biggest contributors to revenue growth now. It’s also a very important driver for profits, since Amazon keeps profit margins thin or nonexistent in other areas to boost sales. eBay also expects to steal Amazon customers with offers of $5 same-day delivery everywhere. eBay’s CEO is so confident about these new programs that he predicts his company will double annual revenues to about $22 billion by 2015.

Google, too, is working hard to take Amazon profits. Last week, Google offered its own same day delivery service in conjunction with companies like Target (TGT), Office Depot (ODP), Walgreen (WAG) and American Eagle (AEO). That’s a baby business only in beta now. But Google’s cloud services division also competes with Amazon products, as do several other giant tech companies like Intel (INTC) and International Business Machines (IBM). Amazon doesn’t break out earnings from this business, which includes major contracts with Netflix (NFLX), but it’s likely one with much higher profit margins than books or Kindles.

Amazon’s preferred method of beating competition has been to cripple it with low prices, but of course Amazon gets hurts, too, making it the Suicide Bomber of Retail.

Just last week Amazon cut the price of one of its Kindle Fire models, even though the company likely makes little money on those sales already. Sacrificing profits for revenue growth has worked well enough so far to keep investors piling into Amazon shares. But Amazon’s profit margins are next-to-nothing now, and investors typically want positive earnings trends as the law of big numbers necessarily drops revenue growth. Companies like eBay, with its very profitable PayPal division, and Google can get away with a lot more cutthroat discounting now than Amazon.

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AMZN Operating Margin TTM Chart

Investors have excused Amazon from ordinary fundamentals expectations for a many years now, and that faith has made them rich. But if the competition does manage to crimp sales, investors might start asking for more traditional evidence that these shares can continue to rise. Amazon hasn’t yet proven it can deliver that kind of reassurance.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.


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