Do you wonder how Amazon manages to maintain such a vaunted stock price, year after year, on relatively middling returns? It appears that the market has, for a very long time, rewarded the ultimate uncertainty of Amazon’s revenue and margins. A stock investor who still believes that Amazon will eventually supply huge revenue, outsized margins, and strong cash flows might buy the shares today under the assumption that the company will grow into its valuation. At some point in the future, the reasoning goes, Amazon will get there.
But what if there is no “there” where Amazon is going? Once a ground-breaking company achieves a stabilized rate of growth and predictable financial returns, the market takes a more pragmatic view of that enterprise. Investors’ optimism about a company’s future prospects gets partially replaced by hand-wringing over how sustainable its results will be. Amazon has actually already reached the stage of stabilized revenue growth. Growth slowed to a 27% rate of revenue expansion in the last year. No brash newcomer anymore, the company enjoys the number 56 spot in the Fortune 500 list, based on 2011 revenue. With 2012 revenue of $61.1 billion, Amazon will likely crack the top 50 when the next list comes out in May.
It’s time to value Amazon for what it is today
Accepting the reality that Amazon has grown up makes it much easier to value the company against existing businesses. Competitor Ebay (NASDAQ:EBAY) is juicing its revenues at an annual clip of 21%, and it trounces Amazon on a profitability basis, generating $2.6 billion of net profit on only $14.1 billion of sales. The market values Ebay at 28.6 times trailing 12-month earnings, which is an aggressive, but realistic, multiple. Apple (NASDAQ:AAPL), huge as it is, surprisingly is growing faster than either Amazon or Ebay, with higher profits. Like Amazon, its revenue is comprised primarily of retail sales, supplemented by services revenue. Worried about the impossibility of Apple sustaining its phenomenal results, the market has steadily discounted the company’s success in order to sleep at night. As Amazon transformed our purchasing habits, Apple transformed our relationship to technology. But it now trades at just under 10 times trailing 12-month earnings.
Final thought: a rational course of action
Each quarter that Amazon posts this year will be meaningful. If you own the stock, look to two trends: the first is revenue growth (or deceleration). The second is net profit margin — Amazon needs to start putting up consistent and impressive bottom line numbers. If you don’t own Amazon stock, avoid buying it at these levels. It’s had a great ride into the stratosphere. But sometimes, as Red Bull space jumper Felix Baumgartner can attest, the way down is fast as it is long.
The article Ground Control to Amazon: “Seattle, We Have a Problem” originally appeared on Fool.com.
Fool contributor Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, Cisco Systems, and eBay. The Motley Fool owns shares of Amazon.com, Apple, and eBay.
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