My Amazon Mistake

NEW YORK ( TheStreet) -- I've said it before and I'll say it again: Valuation will always matter.

But in the tech sector, a complaint about a high P/E ratio is like protesting the wetness of water. Then there are relative comparisons such as Apple's ( AAPL) incredibly low P/E of 10 versus Amazon.com's ( AMZN) 3000.

Investors often air legitimate concerns such as slowing growth, but Amazon has been expensive for over a decade and has never stopped growing. I've now reached a point where I can admit that not buying the stock because of valuation concerns was a mistake. Today Amazon deserves every ounce of respect it gets.

While there's no denying Amazon is solid as any, and has arguably the best CEO in the business today, there's always been another concern: When will Amazon's bottom line matter and how long can investors afford such high premiums without meaningful profits?

Coming off a lackluster third-quarter, Amazon answered this call in the fourth quarter.

For the period ending in December, Amazon posted net income of $97 million, or 21 cents per share, on revenue of $21.27 billion. These results were much lower than analysts' estimates of 27 cents per share on revenue of $22.26 billion. What's more, on a year-over-year basis, net income dropped 45% -- hence the constant concerns about the bottom line.

However, revenue climbed 22% year over year, continuing its streak of sales growth that has now averaged 32% over the past six quarters. Nonetheless, Amazon still missed the Street's revenue estimates of $22.26 billion. So despite the holiday quarter expectations, Amazon missed on both the top and bottom lines.

However, following the report, shares rallied up almost 10%. The Street loved that Amazon improved in the one metric for which it is often criticized -- profitability, and in particular operating margin. That overall margins arrived better than expected affirmed the company's ability to establish better competitive leverage.

The company showed improved shipping performance/costs. Amazon also did well by focusing on higher value services, or those that generate the most profits. As a result, gross margin advanced by three and a half points. Likewise, pro forma operating income increased 47% while operating income rose 56%, both of which led to a margin improvement of a half point.

This was certainly an excellent performance, for which Amazon's CEO Jeff Bezos offered the following:
We're now seeing the transition we've been expecting. After five years, eBooks is a multi-billion-dollar category for us and growing fast -- up approximately 70% last year.
In contrast, our physical book sales experienced the lowest December growth rate in our 17 years as a bookseller, up just 5%. We're excited and very grateful to our customers for their response to Kindle and our ever-expanding ecosystem and selection.

While the deterioration of the physical book business is not a surprise, the 70% surge in the eBooks certainly is. It's no coincidence that Bezos is still raving about the popularity of the Kindle Fire. As noted, profitability has been the most popular bear argument.

For instance, although Amazon sells millions of its popular tablet, the company takes a loss on each unit sold. But this has to do with Amazon's infrastructure builds, which is working perfectly as evident by the 70% growth in eBooks.

The Kindle Fire has become one of the real threats to Apple's iPad dominance. Amazon's Prime movie streaming business continues to gain traction on Netflix ( NFLX). So Amazon may not want to disrupt its ecosystem with price increases.

I think this makes sense given Netflix's recent subscriber surge in Q4 -- including adding over two million domestic streaming subscribers plus 1.81 million internationally. Besides, with Netflix growing so quickly, it will continue to be the subject of M&A debates including Google ( GOOG), which owns YouTube and has its own TV ambitions.

With rumors of an Amazon phone still swirling, there are plenty of gains to be had and plenty of growth opportunities ahead. The phone scenario is interesting -- as analysts insist the device will be launched by the second half of the year, it is not yet certain which operating system Amazon will use for its phones.

Although the company has a relationship with Google -- Android powers the Kindle Fire -- I wouldn't be surprised if Amazon lined up with BlackBerry ( BBRY). I don't see why Amazon would want to enter a new market while also placing itself at a disadvantage by helping a rival -- albeit (still) another partner.

Apple's IOS and Google's Android currently hold the top two spots in terms of market share. It makes sense for Amazon to try to "level the playing field" by raising the profile of a less-threatening rival such as BBRY. By doing this Amazon would potentially weaken the top two players while helping itself to a loyal base of BlackBerry enthusiasts.

Bezos is too smart to not realize this. That the stock surged after its earnings announcement suggests investors don't care AMZN missed EPS estimates. They continue to salivate over the company's top-line growth. It's hard to blame them at this point.

So far the company has answered several of its critics who have wondered if it can grow into its valuation. I was one of them. Now I regret not owning the stock as I waited for proof.

At the time of publication the author had a position in AAPL.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Saintvilus is a private investor with an information technology and engineering background and has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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