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Is This the End for Amazon Bulls?


Yesterday's earnings report showed Amazon's margins are weak, but that hasn't been a problem in the past.

Momentum favorite (AMZN) is taking a beating this morning after delivering a disappointing third-quarter earnings report yesterday afternoon, trading down to around the $200 level.

Now at some point in the very distant future, perhaps around the year 2035, I see Amazon surpassing Walmart (WMT) in annual sales. (Also see Infographic: Wal-Mart Vs. Amazon.)

Nonetheless, we must still take a serious look at the company's growing pains.

So let's take a look at the headline facts and figures:
  • Amazon closed at $227.15 yesterday, trading at over 100 times expected full-year earnings -- in other words, priced for heavenly perfection.
  • Revenues grew 44% year-over-year to $10.88 billion, coming in just under a consensus of $10.95 billion.
  • Earnings came in at $0.14 a share, $0.09 below expectations.
  • Operating income fell to $79 million, down from $268 million last year.
  • Media sales rose 24%, while electronics/general merchandise sales rose 59%.
  • Fourth-quarter revenue guidance is $16.45 billion versus Wall Street's $18.2 billion forecast.
  • The company expects fourth-quarter operating income of minus $200 million to plus $250 million.

Okay, so technically, we're seeing the same old story with Amazon -- near-term profitability is getting killed due to long-term growth initiatives.

Amazon is spending tons of money building its global distribution network and expanding the installed base of its low-margin Kindle family of devices, including the upcoming Kindle Fire tablet.

But what's really interesting is that the report was more or less a carbon copy of what we saw with the company's Q3 2010 earnings report (see Amazon Making all the Right Long-Term Moves).

What happened back then?

Amazon forecasted lousy fourth-quarter operating-income guidance due to investments in distribution centers and losses on the Kindle e-reader.

But subsequently, despite continued margin disappointments (see Why Amazon's Low Margins Deserve Praise), the stock's risen over 30% vs. a 17% increase for the Nasdaq.

So how does that happen?

Well, it's actually pretty simple. Investors are buying into the idea I implied above: Amazon is seen as the future giant of retail. It is not and will not for the foreseeable future be a margin story.

In fact, I think that the day you see Amazon's margins rising significantly is the day you'll see a compressed valuation because the company will have matured.

Just look at Microsoft (MSFT). It's more than doubled sales and profitability over the past decade, yet the stock's down big as the earnings multiple keeps on shrinking. Why? Because Microsoft is seen as staid and as a hero of the last generation, not this one.

Big multiples go to young guns, and given Amazon's astounding revenue growth and room to take more retail market share, it's still pretty young.

I'm holding my nose as I say this, but I think Amazon's going higher through year-end. And though I hate qualifying statements, I think longs should pack their barfbags.

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I'd regard Amazon's results as negative for the following two names:

1. Barnes & Noble (BKS)
Amazon is not now and never will be afraid to lose money on the Kindle, and that seriously hurts B&N's Nook reader. Also, Amazon's attempt at 100% vertical integration in the book industry, as evidenced by its rapidly-growing publishing arm, is a major, major problem for both competing retailers and the publishing complex -- more to come in a future article.

2. Best Buy (BBY)
Amazon's consumer-electronics sales are continuing to skyrocket. My back-of-the-envelope math indicates that Amazon is a much, much bigger threat to Best Buy today than Circuit City was just a few years ago. The idea that Best Buy is Amazon's real-world showroom is a very real threat.

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No positions in stocks mentioned.
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