Heres the dirty little paradox about Amazon (NASDAQ: AMZN ); the reason
investors often are unhappy with the online-retailers management, even while
they value the stock at 90 times its forecast 2012 earnings: To compete
aggressively in the long run, Amazon has to risk a lower near-term stock price.
Of course, competing successfully can secure profit growth that can keep the
stock rising for years. Amazons playbook always has been to keep costs as low as
possible, even if it means razor-thin profit margins. Amazons net profit has
long been below 5% of revenue as the company sells goods at prices below its
rivals and introduces loyalty programs like Amazon Prime, which increases sales
per customer but requires Amazon to eat a lot of shipping costs. For the past
couple of months, investors once again have been bracing for a decline in profit
margins at Amazon, thanks to the introduction of the Kindle Fire tablet. After
Amazon announced the $199 tablet, it soon became clear the price tag was below
what it costs Amazon to make it. And so, as InvestorPlaces Anthony John Agnello
pointed out last month, "Amazon might burn a hole in its pockets with the
Kindle Fire even if it's a success." Thats worrisome to investors. Because
during the past six quarters, Amazons net profit margin has fallen from 4.2% to
0.6%. Some of the more bearish analysts are forecasting that Amazon will post a
net loss as high as 26 cents per share this quarter, compared with a
14-cents-per-share profit last quarter. The fourth quarter, of course, is
Amazons busiest quarter by far, with nearly 40% of its annual revenue. A loss in
the fourth quarter would be especially disconcerting. Amazons stock has fallen
27% in the past two months on these concerns, closing at $180.21 on Wednesday.
For its part, Amazon doesnt seem troubled by this outlook. While Kindle Fire
sales will weigh down margins in the next couple of quarters, it could boost
revenue and profits of content sales for years as Kindle owners buy not only
e-books, but movies, music and games to enjoy on the tablet. Of course,
investors and analysts might be underestimating the hurt that the Kindle Fire
will put to Amazons earnings next year. On Tuesday, Goldman Sachs analyst
Heather Bellini said she expects the gap between the Kindle Fires launch and the
eventual increase in digital content sales to give Amazon a 2012 EPS of $1.42 .
That figure is not only significantly below the Streets consensus estimate of
$2.02 per share, it would be Amazons lowest EPS since 2007, when it posted $1.12
per share. It also would mean that Amazon is trading at a forward P/E ratio of
127. Investors dreading a short-term swoon in profits might understandably be
taking heart in recent reports of the clumsy launch of the Kindle Fire. Some
users are discovering the tablet doesnt work right out of the box. Others find
it so awkward to use that one usability expert declared " the Fire is going to
be a failure. " Then there were reports that the Kindle makes it easy for
children to " charge up a storm ." But even that development could hurt one
of Amazons most cherished assets: its image as a consumer-friendly brand. If the
Kindle Fire does fail, Amazons status as a tech innovator would be harmed, and
it could open the door to other digital content portals such as Apple s (NASDAQ:
AAPL ) iTunes or a music/video/app store from Google (NASDAQ: GOOG ). Amazons
best hope is for the Kindle Fire to be a big hit; to reach the broad base of
consumers who want a tablet but find an iPad too costly. That will mean a lot of
discomfort for AMZN investors focused on the next few quarters. But for
investors with a longer-term view, it could strengthen Amazons role as the place
where many of us buy stuff online. As of this writing, Kevin Kelleher did not
hold a position in any of the aforementioned stocks.
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