We Did Some Math: Justifying Amazon’s Stock Price


A lot of investors are happy to pay dearly for shares of Amazon.com (AMZN) because eventually, the story goes, all those sales will turn into a massive profits. But does Amazon really have a shot at becoming one of those profit machines like Coca-Cola (KO) or McDonald’s (MCD)?

We did the math, or some math, at least.

YCharts compared Amazon’s profits to a few companies close in market cap that investors buy for their earnings performances. Consider tobacco company Philip Morris International (PM), and oil services firm Schlumberger (SLB), as well as Coca-Cola and McDonald’s. We can see by the chart below that these companies do a great job of delivering earnings growth over time.

AMZN Net Income TTM Chart

AMZN Net Income TTM data by YCharts

Amazon, as we know, delivers little or no earnings because it’s focused on sucking up all the customers it can get, whatever the cost. That strategy builds revenues, but it takes a lot of investment and is horrible for immediate profits. Over the past four quarters, Amazon’s EBIT margin was 0.79%. Amazon earns a fraction of what those other companies make on sales. Its actual profit margin is in negative territory this year.

AMZN EBIT Margin TTM Chart

AMZN EBIT Margin TTM data by YCharts

Financial professionals would use a lot more than a couple of data points to estimate how much Amazon needs to grow in order to reach earnings parity with those companies. YCharts offers a long list of metrics like cost of sales to help with that. But even a rudimentary look into Amazon’s EBIT margin and sales provides some insights into the distance Amazon has to go.

Using its tiny EBIT profit margin alone as a guide, we see that Amazon needs some gargantuan sales gains to reach those earnings, which range from $5.52 billion (McDonald’s) to $8.6 billion (Coca-Cola) in the past four quarters. At its current EBIT margin, Amazon, to match McDonald’s earnings, needs to collect $698.48 billion in annual sales (that's far more than Wal-Mart (WMT) brings in). To match Coca-Cola, it needs $1.09 trillion in annual sales. That’s about 10 to 16 times Amazon’s current revenues of $66.85 billion.

So how long will that take? Amazon’s revenue growth rate was 22% year-over-year last quarter, and analyst forecasts estimate a similar level of growth for this full fiscal year and next. If that rate holds, it would take about 12 years to get from $66.85 billion in sales to $698.48 billion in sales, or about 14 years to get to $1.09 trillion, according to a compound growth calculator. The likelihood of sustaining such a rate of growth for that long seems doubtful at best.

But wait … many investors believe Amazon could quickly ramp up that profit margin by raising prices in the markets it already dominates. So let’s assume Amazon could move that 0.79% margin up at will. What would Amazon’s profit margin need to rise to in order to at least match McDonald’s earnings at current revenue levels? About 8.3%. Or 12.9% to achieve Coca-Cola profits.

That seems unlikely as well. Amazon has never in its 17 years of public trading achieved an EBIT margin of much more than 6%. And as it has grown, Amazon has had to compete against abler retailer than its early rivals, Borders (RIP) and Barnes & Noble (BKS). Amazon has kept growing by heavily discounting items, though its service and online platform are certainly attractive. But it doesn't appear that consumers are dying to pay more on Amazon, rather than less.

Yet its shares continue to trade at valuations nearly 20 times the prices of companies that have produced solid earnings year after year after year. (There is such disparity in valuations that we were forced to show them on separate charts.) Among companies exceeding $10 billion in market cap, only Tesla (TSLA) and LinkedIn (LNKD) trade at higher forward PE ratios than Amazon.

KO Forward PE Ratio Chart

KO Forward PE Ratio data by YCharts

AMZN Forward PE Ratio Chart

AMZN Forward PE Ratio data by YCharts

There are, of course, other reasons investors might value a company highly even if strong earnings don’t appear imminent. That’s one reason YCharts offers a multitude of ways to evaluate a company’s share price, like price to cash flow, price to tangible book value, and enterprise value to free cash flow, to name a few. But for big earnings over the long run? There are a lot of cheaper shares worth investigating that have been offering investors the benefits of big earnings for many years. To justify its current valuation, Amazon needs a magic formula of continued growth and widening margins, a combination difficult to come by when you're selling the same stuff as other retailers.

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. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

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