Wall St. Still Doesn't Get Amazon

Is it a tech company? A retailer? And what about profits?
At Closing, May 23th
1601.86 USD

Amazon just reported its most profitable year since 2010. Yet its stock fell by as much as 10 percent on Friday as Wall Street retreated from its overexuberant expectations for the e-commerce giant. 

Caught by Surprise

Investors reacted sharply to Amazon profit that fell short of expectations.

Source: Bloomberg

Intraday times are displayed in ET.

Like political campaigns, stock investing is built on narratives that don't always match reality. Chipotle will capitalize on Americans' appetite for fresh and organic food -- until it turns out to be a germ factory. U.S. automakers are toast because no one wants to buy cars -- until auto sales have a record year. It's not always clear how corporate narratives are crafted and settle into our brains, but they are tough to change once they do. 

The Amazon narrative for years was the company as "Amazon.Bomb," the cash-burning dot-com plaything that was sure to collapse any minute. For most of the 2000s, a minority of Wall Street analysts recommended that investors buy Amazon shares, according to Bloomberg data. Wall Street didn't believe in Amazon for a long, long time -- until it did. 


Part of the problem was that Wall Street couldn't wrap its head around how to value the company: Is it a retailer, a tech company, a shipping and logistics business? Retail analysts were comfortable with a low-price retailer with scant margins but didn't understand the steep valuation attached to the tech side of the business, while tech analysts all but overlooked the retail component and were puzzled by its lack of margins.

The narrative began to shift after the 2008 financial crisis. Retail was in the doldrums. Consumers pulled back spending. But e-commerce somehow kept charging ahead.

Once Internet sales jumped to 5 percent of overall retail sales from 3 percent, Wall Street started believing a real shift was unfolding in the way people shop, said Bloomberg Intelligence analyst Paul Sweeney. 

Clicking Ahead

U.S. e-commerce sales as a percentage of total retail sales

Source: U.S. Census Bureau

Amazon became an intriguing but still comically unprofitable company. It was the Kleenex of online shopping, plus a purveyor of a new type of computing services. The "buy" ratings started to dominate.

Around the beginning of 2015, Wall Street became a true believer. The narrative formed that Amazon had finally achieved the size and power to reap serious earnings from investments Jeff Bezos had made with shareholders' money.

High Hopes

Wall Street expects Amazon's earnings to boom in coming years.

Source: Bloomberg

* The 2016 to 2018 figures are the average of analysts' estimates.

The perception shift drove Amazon to the second-best performing stock in the S&P 500 last year, just behind Netflix. A company already bigger than all but a handful of public companies more than doubled its market value in a year, to more than $300 billion.

On Thursday, the narrative of Amazon's fast track from puny to plump profits met with reality. It turned out Bezos doesn’t care about narratives. 

Last year was Amazon's most profitable year since 2010. But putting that in context, Amazon's 2015 net income of $596 million is roughly equivalent to Microsoft's earnings in 11 days.

Over the last year, Amazon’s retail operations after paying operating costs turned each dollar in sales into 2.7 cents of profit. Even Walmart manages twice as much operating margin. Amazon's forecast calls for at best an operating margin of 2.7 percent in the three months ending in March.

Those kinds of dinky earnings would have been perfectly fine a year or two ago. Investors wanted Amazon to take nearly every dollar coming in the door and spend it on building shipping centers, computing networks, a Hollywood-like entertainment machine and more. 

But once Amazon started posting profits, many investors thought the trajectory would continue in a more linear fashion. 

"What investors want is to have some sort of predictability of how they will grow their margins. Investors are trying to cope with this risk that Amazon goes back into spending mode," Piper Jaffray analyst Gene Munster told Bloomberg TV this week. 

He also said Amazon executives missed a chance on the company's earnings conference call to "comfort investors about how margins are going to trend over 2016."

Just look at Amazon's guidance for this coming quarter: Amazon's range for operating income is $100 million to $700 million, or "a wide enough band to drive one of Amazon's delivery trucks right through it," said Nomura analyst Bob Drbul. He initiated coverage on Amazon in 2014 with a buy and hasn't wavered since -- but even he lowered his price target on Friday to $750 from $850 and expects profits to be "lumpy." 

One quarter falling shy of profit perceptions doesn't mean Amazon isn't an incredible retail juggernaut anymore. All signs point to Amazon accounting for bigger chunks of total e-commerce spending. And it doesn't mean Amazon can't make real money. It just means Wall Street got ahead of reality and got Amazon wrong. Again. 

--Rani Molla contributed graphics to this column. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the authors of this story:
    Shira Ovide in New York at sovide@bloomberg.net
    Shelly Banjo in New York at sbanjo@bloomberg.net

    To contact the editor responsible for this story:
    Daniel Niemi at dniemi1@bloomberg.net

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