One of the biggest negatives surrounding Amazon.com, Inc. (NASDAQ:AMZN) is the company’s sky-high price-to-earnings ratio. According to Google Finance, AMZN stock currently trades at an eye-popping 191 times its trailing earnings of $4.36 per share.
But Amazon has at least given investors the courtesy of growing profits to try to somewhat justify the lofty valuation. That 191x is on trailing 12-month earnings of $4.36 per share. In fiscal 2015, AMZN earned $596 million, or $1.25 per share. In 2014, it lost $241 million, which translates into 52 cents per share.
It’s obvious Amazon stock investors care about growth, not valuation. AMZN’s sky-high P/E has been in place for years, and will likely continue for some time.
And that’s actually OK. Here are two important reasons why:
Amazon Revenue Growth
Amazon is still one of the best growth stories in today’s market.
When the company releases 2016’s final numbers Thursday, Feb. 2, analysts expect Amazon to post revenue of $137 billion. That’s an improvement of more than 25% versus 2015’s top line — a difficult feat when you’re talking about 12-digit sales. And Amazon’s $107 billion in revenue last year was 20% better than 2014.
We live in a world in which S&P 500 constituents are doing well if they’re posting just single-digit increases on the top line. You can blame this at least partly on the strong U.S. dollar, which is weighing down American multinationals. But the fact remains that meaningful growth is a scarce quality in today’s stock market — especially among blue-chip stocks.
Thus, AMZN stock is an easy way for investors to get access to big growth with relatively little risk.
And Amazon is hardly running out of fuel. The company has only begun to expand into grocery and apparel — two huge categories. Trillions of dollars are spent worldwide each year at physical stores. That’s not to mention the other gains Amazon still could make via the smart home, Amazon Web Services cloud offerings and other newer initiatives.
Analysts predict Amazon’s revenue will increase another 22% in 2017, hitting $168 billion. So again — the growth story is still well intact.
But it’s not all about growth. Many AMZN stock bulls argue that we’re just looking at earnings the wrong way.
Amazon Earnings: Better Than They Seem?
One thing that separates Amazon CEO Jeff Bezos from many other executives is his ability to look at the really, really long-term. He’s also willing to spend billions of dollars on ideas, and is OK with hitting a few duds if it means spawning great new ideas.
Remember the company’s smartphone? The Amazon Music Importer? How about a website called Askville? I’m guessing you might remember the Fire smartphone, but not the other two. Amazon lost $170 million on its smartphone alone.
This kind of risk taking is an inherent part of Amazon’s culture. It’s the line of thinking that prodded the company to introduce some of its biggest winners to date, like cloud services, Prime shipping and the Kindle.
Thus, many investors look at AMZN stock in a different way. They look at the company’s operating profit, then they add back its substantial research and development costs to get a “truer” sense of profitability.
Admittedly, that changes the picture dramatically.
In its most recent quarter, Amazon produced net income of $252 million, which across 485 million diluted shares became diluted earnings of 52 cents per share. At the time, AMZN was trading at $822 per share. If we annualize that profit (not a perfect measure, as quarterly earnings fluctuate — this is just for an example), we’re looking at a P/E of 395.
But Amazon also reported operating profits of $575 million, and spent $4.14 billion on R&D — a significant expense. Add those together, and you get $4.715 billion, or $9.72 per share. Annualize that, then divide the share price by that, and you get a P/E of about 21.
Let’s take the actual numbers. Amazon currently trades for 190 times trailing 12-month earnings, as we said above. However, over the past four quarters, Amazon spent $15.11 billion on R&D and posted operating profits of more than $4 billion. That comes to $40.19 per share combined, and puts AMZN stock at a P/E of just more than 20.
That’s a lot of creative accounting, so take that with a spoonful of salt. But it’s an interesting argument.
Bottom Line on AMZN Stock
Amazon continues to be one of the best growth stories in today’s market. As long as that continues, investors aren’t going to care about the headline P/E ratio. It just doesn’t matter. AMZN stock has doubled several times over despite it.
Amazon is solidly profitable, even if the bottom line isn’t as large as investors typically would like. But those earnings are being reinvested back in the business — which is what a high-growth company like Amazon should be doing anyway.
As of this writing, Nelson Smith did not hold a position in any of the aforementioned securities.