Amazon Gets Its Props

The stock returns to 'darling' status as analysts gush over the Internet retailer's improved margins.
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Updated from 1:27 p.m. EDT

Amazon.com

(AMZN) - Get Report

was basking in its newfound respect on Wall Street Wednesday after a surprisingly strong earnings report pushed the stock 12% higher and prompted praise from analysts over its operating margins.

Amazon was the latest Internet giant to throw investors a curve ball. After six months of growing consensus that e-commerce was wilting while Internet search was unstoppable, the second quarter saw an abrupt reversal in those trends. In addition to Amazon,

eBay

(EBAY) - Get Report

surprised investors with a strong earnings report, while

Yahoo!

(YHOO)

and

Google

(GOOG) - Get Report

had reports that, while showing healthy financials, failed to sate investor appetites for growth.

Amazon shares were trading up $4.62, or 12.3%, on Wednesday after it posted a 12 cents-a-share profit, 2 cents above the consensus forecast of analysts polled by Thomson First Call. Revenue rose 26% to $1.75 billion from $1.39 billion a year ago, in line with analyst estimates.

As has been the case in recent quarters, attention was focused on Amazon's operating margins, which had been eroded as the company spent more on marketing and incentives such as free shipping, as well as rising fulfillment costs.

Last quarter, Amazon's operating profit of $104 million was 6% of revenue, an increase above its first-quarter operating margin of 5.7%. Analysts had been bracing for another quarter of deteriorating profit margins from Amazon, which have been a sore point with investors. Operating margins were still down from the year-ago figure of 6.2%.

The sequential improvement had analysts seeing Amazon's outlook in a brighter if somewhat cautious light. Piper Jaffray raised its price target on the stock from a bearish $30 to a more bullish $44, giving Amazon the benefit of the doubt.

One encouraging sign that Piper and other research desks pointed to was the rise of Amazon's "other" revenue, from newer businesses like co-branded credit cards and third-party sales. In particular, Amazon's Merchant.com business, in which Amazon sets up and manages the sites for other retailers, is growing at a healthy clip. Such outsourcing offers Amazon a high-margin source of revenue.

Still, Piper analysts Safa Rashtchy and Aaron Kessler left open the possibility that Amazon can't sustain its higher margins -- a skepticism invited by Amazon's own reluctance to offer more specific data that could silence doubters.

"If the margins are indeed sustainable, then we will see continued improvements and a significant increase in profitability," the analysts wrote in a report. "On the other hand, if this is a one-time event, we will go back to margin fluctuations that have marked Amazon's performance over the past year or so." Piper has no underwriting relationship with Amazon.

Others were feeling more bullish on Amazon's future. Legg Mason analyst Scott Devitt suggested Amazon's strong quarter strikes a blow against the argument often heard among Amazon bears that the company is simply another retailer, and should be valued as such. Legg Mason has no underwriting relationship with Amazon, and the firm owns a 15.3% stake in the e-tailer.

"We believe the company has created a unique brand and brings a differentiated value proposition focused on creating a superior customer experience to the consumer," Devitt wrote in a report. "Amazon does this in a high-growth industry in which operating leverage is just beginning to show for the leaders."

Devitt's note urged a longer-term view that must have sounded soothing to Amazon executives. "There is a misconception in the investment community that companies should be focused on maximizing near-term profits," he said. "We believe quite the opposite and believe Amazon is just beginning to reap the returns on many well-placed investments, which should make happy those long-term shareholders that have believed in the process."