bulls-vs-bears

Jeff Bezos, Amazon’s CEO, has garnered a lot of attention for keeping his company at breakeven. Almost like clockwork, Amazon.com (Nasdaq: AMZN) increases both its R&D and Sales & Marketing expenses exactly inline with any increase in gross profit.

This controversial strategy has led to polarized investor sentiment regarding Amazon. Bulls argue the company is wisely investing for its future, and bears see a stock trading for a P/E of 300+ with not enough earnings growth in sight.

They can’t both be right? Or can they? Below we dive into the viewpoints of both camps.

Bulls vs. Bears: The Amazon Bull

Amazon is always working on entering new growth markets. This strategy helps to diversify the company’s revenue stream away from its core e-commerce platform and leads to stronger top-line growth.

Historically Amazon has always been able to successfully reinvent itself. Over the years the company has transitioned from simply selling books online to an e-commerce platform offering goods and services in hundreds of different categories. Amazon is always getting ready to enter the next high-growth market.

Two of the most notable projects Amazon has been working on to expand its reach are the development of its own Android-based tablets and smartphones and its cloud-storage business, Amazon Web Services (AWS).

The Kindle and Fire Phone represent an entrance into the booming consumer-tech market, which Apple has nearly monopolized. Though the Kindle has been around since 2007, it has yet to garner the ubiquity of the iPad or any Google or Samsung tablets. That being said, the product is not a failure.

The Kindle drives business to Amazon’s e-commerce platform and introduces consumers to Amazon’s version of a mobile operating system. The Fire Phone is an extension of both these strategies, and marks Amazon’s entry into the smartphone market, which is a much bigger and more lucrative market than tablets.

AWS could be a real game changer. This cloud storage business is gaining major traction and acting as the catalyst for a major transition in IT from the private to the public cloud.

AWS is already having an impact on Amazon’s overall growth. The company reports this revenue in its ‘other’ category, which saw sales rise 60% in Q1 from $750 million to $1.2 billion. In theory this revenue is higher margin, and has a lot of room left to run. In fact one analyst (from Macquarie Capital) says AWS could be worth $50 billion if not more, by itself in 2015. That would be enough to represent one third of Amazon’s entire current market cap.

Bulls vs. Bears: The Amazon Bear

Amazon bears almost exclusively utilize a valuation argument. With a 2014 earnings consensus of just $1.05 per share, shares trade at a P/E of about 300. This is a very expensive valuation by almost any standards.

Despite torrid annual revenue growth north of 20%, Amazon’s miniscule profits (relative to its market capitalization) have remained essentially flat since 2011. For the past three years the company’s net income has been between $600 and $900 million.

Up until now, higher revenue has not translated to higher profits; bears feel this trend is likely to continue.

Negative speculators and short sellers argue that even if profits ever begin to materialize, expectations are far too high. Amazon would have to increase its 2014 EPS by a factor of 10, just to be trading at a P/E of 30 (still lofty by most standards).

Conclusion

Buying Amazon is really a bet on the execution of Jeff Bezos and the company’s senior management to successfully expand into new business lines and significantly ramp profitability down the road.

The Kindle & Fire Phone, as well as AWS each have the potential to be profitable multi-billion dollar businesses. If they were to operate with healthy margins, at scale, they would no doubt provide a boost to the company’s long-term valuation and stock price.

If these investments never gain the adoption needed to make an impact on Amazon’s bottom line, then the company’s P/E will have to come down to accommodate for this.

Some important things to watch going forward will be the continued growth of Amazon’s ‘Other’ revenue category. This will be a good gauge of the future of AWS, and other new ventures. Market share data regarding the penetration of the Kindle and Fire Phone, will also be critical in determining the success of that business line.

Although Amazon’s P/E is at 300+ now, it may not be there for long if Bezos decides to cut R&D spending and focus on the growth of its most successful products and software.

At current levels I can’t help be bullish on Amazon’s prospects. Its P/E makes the stock more expensive than it really is, because the company is operating at breakeven. Given that shares trade at just 2x trailing sales, Amazon looks cheap relative to other major software companies. For example, giants like Oracle, EMC, and NetApp trade for at least 2-3x sales, despite much lower growth profiles.

The company’s investment in growth has paid off with its top-line booming from $34 billion in 2010, to $74 billion in 2013. These are the type of numbers I’m willing to sacrifice near term profitability for.

The One Company You’ve Never Heard of – But Smartphones Couldn’t Exist Without

Four months from now Apple will be releasing the most technologically advanced phone on the planetAnd cautious estimates have them selling 200 million of them. While we love Apple (it’s in our 100k portfolio) we’re recommending a much less known company today…a company no one is talking about.  A company that provides the technology, without which, smartphones couldn’t exist.  It’s the company reaping massive profits each time a new Apple (or Samsung) smartphone is activated. In fact, as mobile data usage explodes in the year ahead, its stock is set to soar! Shares are already on the move. So, before this stock moves any higher, read our latest report for all the details: Click here for the full story.

Published by Wyatt Investment Research at