Amazon (AMZN) - Get Report is a symbol of growth and disruption, boasting fantastic revenue growth and becoming the dominant player in many of the markets which it enters. But are shareholders likely to benefit from all this? I argue that they will not.
Insatiable Growth -- Looking at the Facts
We all know the quote that "growth is vanity, profit sanity and cash is reality," right? Therein lies the problem for Amazon.
For so many years, Amazon has been the one stock to own, offering investors strong and diversified growth, so much so that investors have stopped questioning where the growth is actually coming from.
Any time that the last of the doubters capitulates and invests in the stock out of Fear Of Missing Out is when doom-and-gloom skeptics go from being a nuisance on the edge of the stock to being worth listening to.
Accordingly, for more than 10 years, Amazon has succeeded. Nobody today doubts what Amazon has achieved in the past. But knowing that Amazon succeeded in the past is of little advantage now when it's already one of the most valuable companies in the world.
Further compounding issues for shareholders, Amazon's Q1 2019 results, which will be announced next Thursday, are likely to point towards its growth rate being -- in the best-case scenario --up around 17% year-over-year.
In fact, at the mid-range of its Q1 2019 guidance, there is a very realistic scenario that its revenue might only hit 14% growth year-over-year, which would be the lowest growth rate Amazon has had in more than 10 years. This will come at precisely the time when investors sentiment is sizzling hot and pricing in annual revenue growth of above 20% for at least five or more years.
A Different Narrative?
Amazon's strategy going forward is likely to be focused on distracting investors and analysts as much as possible away from its diminishing top-line growth and towards its expanding operating income margins.
And there is certainly enough of a story to go on here. Amazon's operating income margin in Q1 2017 stood at 2.8%, while a year later, it was 3.7%. Amazon finished 2018 with the best annual income margin it's ever posted at 5.3%. Looking ahead, at the mid-range of its Q1 2019 guidance, Amazon's margin would be 4.8%, or $2.8 billion, for a 47% jump in operating income year-over-year.
If Amazon was to continue to improve its operating margin, this could be a promising story. The problem, though, is that Amazon's operating income of just over $12.4 billion for 2018 is simply not big enough to support its $900 billion market cap and a valuation of 75x operating income before taxes and interest.
New Growth Opportunities?
Growth companies only have so many levers to pull on to expand margins. Amazon needs some growth to support its heady multiples. Thus, Amazon will satisfy investors' unquenchable thirst for growth by highlighting its strongest growth opportunities, such as advertising and subscription services, as well as Prime membership sign-ups.
However, these new business units, despite their fast growth, account for less than 11% of Amazon's total revenue, so it's reasonable to ask whether Amazon has already had its day in the sun. For now, Amazon continues to be priced for perfection.
The Bottom Line
A few months ago, Amazon CEO Jeff Bezos reminded employees that most large companies have lifespans of around 30-plus years, not 100-plus years. Accordingly, Amazon continues to be the poster child for an exciting new era akin to General Electric (GE) - Get Report in its heyday.
But Amazon won't last forever and I argue that its growth rate has started to dwindle, and its share price is not yet reflecting this.
The author does not have positions in any stocks mentioned.