Amazon.com: When Short-Term Profits Don't Matter

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Amazon.com ( AMZN) has a price-to-earnings ratio of about 140.

For gaggles of investors, such a high P/E is reason enough to sell or short the stock.

In fact, loads of investors appear to invest almost solely on the basis of P/E ratios and other quantitative metrics that measure "valuation."

That's why you see so many people running around calling Research In Motion ( RIMM) and Radio Shack ( RSH) "value plays" as each stock races to the bottom.

Meanwhile, loads of investors yowl about lofty "valuations" as they call stocks like Lululemon ( LULU) and Chipotle Mexican Grill ( CMG) shorts all the way to the top.

Amazon.com gets the same rap as Lululemeon and Chipotle Mexican Grill.

I don't usually subscribe to "you're either with us or against us" dichotomies. The world is too complex for that. But when looking Amazon, it's useful to place people into two camps, although some people fit into both camps.

  • Camp One: People who make decisions based on the here and now, and on the hard data that sit in front of them. It's black and white: AMZN has a P/E of 140, so the stock is overvalued and it must one day crash to a more reasonable valuation. Nothing you say can change these people's minds.
  • Camp Two: People who can take into account the present yet discount it to consider a longer-term, bigger-picture perspective. Sure, AMZN has a P/E of 140 and a somewhat deteriorating bottom line, but why? Is Jeff Bezos so stupid that he's running this thing into ground? Or is there something bigger and more meaningful at play here?

To truly appreciate Amazon.com and be able to rap your head around its "valuation," you need to either be a member of Camp Two or at least be willing to make the attempt to think like Camp Two thinkers.

For some folks, that's simply not possible. And, again, that's not a knock. It's no different than my poor visual-spatial skills preventing me from being able to fit all of the luggage into the trunk. I can write out a plan of how to do it in chicken scratch and get it done. My wife, on the other hand, has no use for my scribbling and can picture how the trunk will look before she starts loading it.

Camp Two thinkers -- I think I can safely include Jeff Bezos in that group -- have little time for concern over short-term pressure on the bottom line. They live to see the future and be the future. And that's how they run their businesses.

That's how Pandora ( P) CFO Steve Cakebread explained things at his company when I interviewed him for Seeking Alpha in January.

Following is a summary of that conversation from my Seeking Alpha article:
Cakebread told me that he can list "plenty of companies" that were wildly profitable early on, but are no longer with us. The endpoint -- Pandora is in rapid growth mode. And fast-growing, pioneering companies that are disrupting industries risk sacrificing long-term profitability and sustainability by not investing enough in the business early on just to achieve profits. While you cannot spend recklessly, you have got to spend. In other words, by not spending today to grow in the name of profitability, Pandora could very well not position itself properly for the long haul. Cakebread claims that, ultimately, Pandora can sport a 20% margin.

Cakebread is a CFO, yet he's hardly your run-of-the-mill bean counter. He could down several pints with guys like Bezos and Steve Jobs and never look out of place or run out of things to talk about.

The situation at Amazon.com is strikingly similar to the one at Pandora.

Big spending now sacrifices the bottom line in the near term, while keeping focus on massive long-term opportunity.

Both companies can dominate multiple spaces years from now, but only if they make the investment today.

Pandora not only invests in content, but it is spending aggressively to assemble a sales team that can ramp up revenue by meeting demand for targeted, multiplatform advertising.

Amazon.com spends money on content and fulfillment and reportedly takes a loss on Kindle Fire with tunnel vision towards becoming an even more pervasive force in various aspects of consumers' lives.

There is one key difference between the two companies, however, and it helps explain the inverse correlation between their stock prices.

It has to do with confidence and perception.

Bears and "value" investors cannot get it through their heads. A high P/E does not always mean overvalued, just as a low one does not automatically mean "undervalued."

Again, look at RIMM and RSH. The market assigns value, not an analysts' formula or a finance textbook. Investors have zero confidence in RIMM and RSH's abilities to perform going forward, thus the low valuation.

In contrast, they can see Jeff Bezos and his team executing like they always have at Amazon.

The company has a coherent plan. It is growing and sits on a considerable amount of cash.

Once this investment cycle ends, look out. Amazon Prime will have become a cult.

While I have a similar level of confidence in Pandora, I can see why Wall Street does not.

It still values it high -- because, after all, it remains a hyper-growth stock -- but it beats the company's stock down in a way it rarely does Amazon's. Simply put, Pandora has lots more to prove to investors than Amazon.com does.

Jeff Bezos is a known genius. And, when his company deems itself well-positioned for the long-term, it will pull back on spending and profits will soar. What's funny is that the Camp One thinkers will still get together and lament Amazon's larger-than-life P/E ratio.

At the time of publication, Pendola was long Pandora and Lululemon.

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