Amazon vs. Wal-Mart: Analyst's Toolkit

BOSTON ( TheStreet) -- The argument for online retailers' advantage over traditional stores comes from the supposedly low overhead that allows Web sites such as Amazon ( AMZN) to charge absurdly low prices while remaining profitable.

In reality, that's far from the case. Comparing something as simple and plain as the operating margin leads to insights into a company's operations that may call into question conventional assumptions about the business model. Sometimes the simplest metrics can be the most helpful.

Most industry experts predict every year that consumers will increasingly turn to online store fronts in the holiday shopping season, and invariably they are correct. Amazon's fourth-quarter sales rose 34% in 2006, 42% in 2007 and 18% in 2008, despite America suffering through the early stages of one of the most acute recessions in history. Consumers are becoming more comfortable with purchasing goods online and traditional stores like Wal-Mart ( WMT) and Target ( TGT) are following suit and beefing up their online presence.

Despite having just a fraction of the sales of Wal-Mart or Target, Amazon has a market value of more than $60 billion, $24 billion more than that of Target and more than a quarter of Wal-Mart's, the biggest retailer in the world. Given those figures, one would assume Amazon is fabulously profitable, yet that's not the case. With an operating margin of just 4.4% in 2008 and the first nine months of 2009, Amazon is scraping by with its bargain-basement pricing.

Compared with brick-and-mortar stores, Amazon's margins are even more pathetic. In 2008, Wal-Mart and Target posted operating margins of more than 7%, and both are on pace to finish 2009 in a similar position. Some may argue that deep online discounts are the driving force behind poor margins, but if that were the case, Wal-Mart and Target would have lost ground in recent quarters as both push more of their business online. While neither company breaks out online sales, making a direct comparison isn't possible. Both have remained more profitable than Amazon, making the Internet king look a little worse for wear.

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