It's Spring on Wall Street, But Winter May Be Near for Amazon

TheStreet.com

NEW YORK (TheStreet) -- Back before we worried about Y2K, Amazon.com's earnings releases followed a strict narrative. Amazon reports dismal earnings with the commitment to increase future revenue. Greater revenue will equal greater profits for shareholders if they are patient.

This broken record plays ad nauseum, and each quarter shareholders buy into the greater fool theory because, after all, the price only increases so it must continue to rise.

Other companies don't get a free pass earnings season after earnings season.

Remember when Apple reported record revenue and earnings last quarter? What direction did Apple's stock move after reporting? It went down. Having the best margins in the space wasn't enough, there was fear that margins may compress and that's all it took for a market that was searching for the slightest imperfection.

Apple shares sold off to the level that I didn't believe earnings would have a significant impact. You can read about my thoughts and bullish bias on Apple in the article "Should Apple Investors Even Care About Earnings?"

Contrary to the rest of the relatively sane investment universe, in the previous report before Thursday, Amazon posted a loss, without a clear path to profitability and investors raced each other to buy more stock. Amazon is the perfect example of why I often say a company's value is based on its income statement and balance sheet while a stock is valued from emotion.

After Amazon reported earnings on Thursday, the stock again appeared to enter the Twilight Zone. Starting from a close near $275, the shares hesitated and even weakened momentarily before bursting higher. The speed of the share price moving higher could make the Bellagio fountains envious.


And why shouldn't Amazon's shares move higher? After all, every investor knows the shares always increase after earnings (eyes rolling). Besides, trailing 12-month operating cash flow increased 39%, revenue grew 22%, media revenue up 7%, and electronics and general merchandise (EGM) revenue increased 28%. At first glance, the Seattle, Wash., online book peddler is crushing many notable metrics.

It's only after you dig deeper that you locate the cracks in the armor.

Unlike operating cash flow, the more closely observed free cash flow decreased a stomach-turning 85%. You practically need a micron microscope to find the 1% return on invested capital. Similarly, Amazon's previously pathetic 28 cents of net income fell to 18 cents -- not much of a beat when viewed in that light.

If you're paying attention to Amazon's results, I know what you're thinking -- 18 cents is still a victory because the mean estimate by analysts was near 9 cents. You can't use Amazon's mean estimate as an accurate barometer. The analysts' estimates ranged from a loss of 29 cents, up to a profit of 38 cents. This means two things for investors trying to gauge what 18 cents means in relation to the mean estimate of 9 cents.

Taken as a whole (using a mean or average), the analysts had no clue what Amazon would report. Sometimes a mean or average is valueless in providing a useful number. There is no edge gained by using the mean of 35 analysts with estimates from negative 29 cents up to a positive 38 cents. Amazon's estimate was worse than trying to tell time from a broken clock. At least a broken clock is correct two times a day.

An estimated number is valuable for comparison when the estimates range is small and typically provides a reliable consensus. You're better served using the whisper number or an earnings preview from someone you trust to gain an understanding of how investors may react to any given result.

Secondly, in response to Amazon's 18 cents in earnings versus a mean estimate of 9 cents I have one thing to say. WHO CARES? 18 cents is notable for an earnings result if your company is BlackBerry or Sprint , but when your stock is trading for $275, 18 cents doesn't pay for the tip much less the meal. That 18 cents represents an earnings multiple of nearly 400, and in order to justify buying at this price you have to believe a PE over 400 will remain reasonable.

Piper Jaffray Senior analyst Gene Muster, an analyst you want to pay attention to, summarizes the investment bull thesis in this video "Amazon: It's a No-Brainer to Own, Says Munster" by stating "We believe there needs to be the hope of margin expansion, not actual margin expansion."


In other words, the SS Amazon may continue sailing along placidly without profit until someone decides hope is not enough. Without tangible results, Amazon shareholders rely on the hope of others to come along and prevent the bubble from bursting (sounds a lot like a game of musical chairs).

By increasingly relying on revenue and profits in low-barrier, entry digital products and the expansion of near-delivery fulfillment centers (aka pseudo-retail), I find it incredibly easy to visualize Amazon's shares losing half their value at stomach-turning momentum from the slightest investor shift in expectations.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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