Amazon Gets a Helping Hand

Shares surge after a strong earnings report sends short-sellers to the exits.
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Amazon.com

(AMZN) - Get Report

shareholders were still basking in an earnings afterglow Wednesday following a report that beat Wall Street expectations -- not bad for a company with falling margins and still-questionable prospects.

Shares of Amazon were recently up $4.22 to $37.85, posting a gain of 12.6%.

The Internet retailing giant

said Tuesday that third-quarter earnings fell while sales rose 24%, but both results beat analysts' estimates.

The company's outlook for the fourth quarter also provided a pleasant surprise. Amazon expects sales between $3.625 billion and $3.950 billion, or growth of between 22% and 33%.

First Call was expecting fourth-quarter revenue of $3.68 billion.

Investors clearly welcomed the news that Amazon would rein in spending on new technology, focusing instead on harvesting the investments it has already made. While the company's spending has driven robust top-line earnings growth, it has come at the expense of operating margins.

"The revenue outlook keeps getting brighter, while the bottom line outcome keeps getting dimmer," wrote Mark Mahaney, an analyst at Citigroup. Mahaney reiterated a hold rating for a stock and forecast a price target of $30 in a research note Wednesday morning.

Despite Wednesday's run-up in the stock, it's unclear whether business fundamentals have really changed for Amazon as operating margins continue to deteriorate. And while investors did have reason to be somewhat more upbeat about the company's future after Tuesday's conference call, it's also likely that short-sellers scrambling to cover their positions after better-than-expected results are contributing significantly to the company's surging stock price.

"The stock will likely be strong in the near term due to short-covering, a view that margins and ROIC

return on investment capital have bottomed, and investors trading around the positive holiday-season rhetoric through Thanksgivng," Goldman Sachs analyst Anthony Noto wrote in a research note.

"I can say with a high degree of confidence that a short squeeze is responsible for a lot of this price movement," said Dylan Wetherill, president of ShortSqueeze.com, a site that tracks short-selling interest in stocks. Dylan bases his analysis on the amount of short interest in the stock and the aggressive nature of buying.

A high amount of short-selling made sense of ahead of Amazon's third-quarter conference call. The company had announced dismal results for its second quarter, causing a subsequent sharp selloff in stocks.

However, shares of Amazon rallied almost 30% through the third quarter despite some prominent setbacks. The company's eagerly anticipated Unbox video downloading service was met with negative reception, and Amazon announced that it would dismantle its high-profile A9 search engine.

Despite this, Amazon continues to be richly valued. "Amazon trades significantly above the other Internet companies in our coverage universe, and significantly above Internet-leader

Google

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, despite the fact that Google is growing at a much faster pace," Prudential analyst Mark Rowen wrote in a research note.

But the better-than-expected results are likely to alleviate short-term concerns about the stock, particularly given solid guidance for a quarter headed into the holiday season. Amazon's second quarter saw the breaking of a partnership with Toys R Us, a relationship that contributed nearly $50 million in operating income to the company for the year, notes Citibank's Mahaney. Investors are likely to see a stronger-than-expected fourth quarter as a sign that Amazon has been able to find substitutes, given the high seasonal demand for toys.

Whether the current rally is driven by a change in outlook for the company's fundamentals or simple short-covering is of critical interest to investors looking at Amazon. Goldman's Noto writes that the outlook for the stock could turn if margins continue to deteriorate as competitive pressures increase.

"We would use the strength in the stock as an opportunity to sell," writes Prudential's Rowen. Prudential, Citigroup and Goldman Sachs have investment-banking relationships with Amazon.