Amazon is a wrecking ball. It has bankrupted bookstores, crippled clothing stores, shaken the grocery industry and turned strip malls into ghost towns.
It does all this while barely turning a profit.
Wall Street would punish almost any other company that operated that way. But Amazon gets away with it because investors believe in CEO Jeff Bezos’ vision and Amazon’s ability to keep growing.
“Amazon’s dominance and revenue growth have freed it from the nuisance other firms endure — profitability,” said Scott Galloway, a professor at NYU’s Stern School of Business.
Last year, Amazon earned $2.3 billion, despite posting nearly $136 billion in sales. That’s a super-tight profit margin of 1.7%.
Other tech giants including Apple and Google operate at much loftier margins. Apple posted a 21% margin last year while Google was slighly under 22%. Amazon’s profit margin is even razor-thin for the retail sector. Walmart’s margin was 3.1% and Target’s was 4.5% last year.
Yet shares of Amazon have risen nearly 60% this year. The company’s worth close to $600 billion. Bezos is the richest man in the world, surpassing $100 billion in net worth last month.
Investors continue to reward Amazon’s forward-looking strategy over its earnings. Shareholders are willing to pay $297 for every $1 of Amazon’s earnings. The average for S&P 500 companies is under $24.
Bezos’ sprawling business model isn’t designed with short-term profit in mind. He wants to grab market share and drive up sales, noted Columbia Business School professor Kinshuk Jerath.
One way to do that: Offer lower prices than competitors.
Shortly after Amazon acquired Whole Foods for $13.7 billion in June, Whole Foods slashed prices, forcing other grocers to cut prices to remain competitive.
In a similar move, Amazon is lowering prices on Echo products, pushing rival Google to drop the cost of its Home smart speakers. Apple’s higher-priced HomePod speakers could now have trouble competing.
Amazon is able to take these kinds of risks and experiment in ways that would look puzzling for other companies, explained Piper Jaffray analyst Michael Olson.
That’s because Bezos is playing by a different set of rules than everybody else.
“Other firms are punished for straying from their familiar areas of strength, [but] Amazon sucks value from sectors in which it has had no previous involvement,” said Galloway.
Other sectors can hear Bezos’ footsteps too: CVS made its $69 billion deal with Aetna, which could go down as the largest health insurance deal in history, with Amazon stalking the pharmaceutical industry.
Amazon was able to punish Blue Apron, once a hot meal-kit startup, just by suggesting it might get involved in the home-meal delivery business.
Investors cheer when Amazon enters a new industry or region because its addressable market grows.
Last year, Amazon accounted for more than 53% of online shopping in the United States, according to Slice Intelligence. Jumping into cloud computing and groceries has added a trillion dollars of additional market, according to Olson.
The cloud is Amazon’s biggest success story. It has actually helped Amazon consistently turn a profit for the first time, according to Morningstar analyst R. J. Hottovy.
“The more e-commerce they do the more money they lose,” said Smead Capital Management CEO Bill Smead. “They lose on everything they do except Amazon Web Services.”
Momentum around Bezos’ strategy and a focus on growth companies over value investing in an era of low interest rates has led investors to brush off profit concerns, Smead claimed.
“Jeff Bezos did what he said he was going to do in era coming off biggest financial meltdown in 80 years,” he said. “Investors are willing to capitalize income so far out in the future that it leads them to financial euphoria.”
