Popularity and profitability sound similar, but they are two very different things. Amazon.com (AMZN, Financial) is one of the most visited websites and it is touting its new virtual coins and a rumored 3D smartphone. At the same time, its margins and revenue growth are falling. Amazon promises that it is sacrificing today's profits for future growth and market share, but this cannot continue forever. Its falling revenue growth should be associated with increased margins, but the opposite has occurred.
Is the Web Really That Different?
eBay and Amazon compete head to head in many areas. Both companies operate online market places and Amazon has been working hard to attract more third-party sellers. In an attempt to fend off Amazon, eBay recently simplified some fees and lowered others to make the selling process easier. While eBay isn't as diversified as Amazon, it does have its hand in some related industries through PayPal.
A quick look at the above charts shows that even as eBay's revenue has fallen over the past year, its operating margin has stayed the same. Its profit margin of 4.7% and earnings before interest and taxes (EBIT) margin of 22.5% make the company profitable, even as it moves into new markets.
Amazon's Jeff Bezos says, "Take a long-term view, and the interests of customers and shareholders align." While this is true, it is irresponsible to ignore the short term. Making profits isn't as easy as simply flipping a switch. Companies learn to be profitable by executing in the short term. eBay's history of profitability better positions it to be profitable over the long term. On a valuation basis, eBay is a better deal as it trades at a price to book ratio of 3.36 while Amazon trades at a price to book ratio of 14.13.
What About Traditional Retail Businesses?
Another argument used to justify Amazon's low margins is that it is more akin to a traditional high-volume and low-margin retail business. Wal-Mart perfectly fits this description and yet its EBIT margin of 6.0% and profit margin of 3.8% are significantly higher than Amazon's EBIT margin of 0.6% and profit margin of -0.1%. The charts show that even as Wal-Mart's growth decreased with the global economic slowdown, its operating margin has remained the same. In the same time frame Amazon has seen its operating margin slowly decline.
Taking on a little bit of debt is healthy as it allows companies to enjoy today's low interest rates. Wal-Mart is able to use its consistent profits to optimize its capital structure and enjoy a long-term debt to equity ratio of 0.54, but Amazon's lack of profits makes it harder to acquire debt. It has a long-term debt to equity ratio of just 0.36.
Costco Wholesale is a growing high volume retailer and its margins are also stronger than Amazon's. Costco enjoys an EBIT margin of 3.0% and a profit margin of 0.5%. These numbers are not spectacular, but they are better than Amazon's. It is telling that Costco is able to maintain its profits while investing in local brands and creating superior growth. With annual sales around $100 billion, Costco is many times smaller than Wal-Mart and it has room to continue growing.
Similar to Wal-Mart, Costco is able to use its consistent profits and growth to optimize its capital structure to benefit from today's low interest rates. Amazon comes out as the second rate player as its long-term debt to equity ratio of 0.36 is less than Costco's long-term debt to equity ratio of 0.48.
Conclusion
It is undeniable that Amazon is an innovative company and finds interesting markets to expand into. At the same time, its declining margins and expensive price to book valuation make it a poor investment. Any investment requires a margin of safety to ensure that investors have a low probability of getting burned, and Amazon simply falls short.
To invest in e-commerce, eBay is a better deal. It is profitable and continues to grow along with mobile computing. Costco is a profitable and growing offline retailer with quality products, yet trades at a significantly lower price to book ratio than Amazon. Wal-Mart doesn't have the same growth profile as eBay or Costco, but is profitable and its push into e-commerce could add more pressure on Amazon's margins. From a business and valuation perspective, these three companies are better deals than Amazon.
