Amazon: No Such Thing as Free Shipping
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investors can be forgiven for believing profits are inconsequential. Year after year, Amazon has successfully sold the idea that when it finally does push some of the top line down to the bottom line, it’s “going to be astronomical.”

Eighty four is the number that should burn inside the head of anyone considering picking up this ticking time bomb. Amazon’s price-to-earnings multiple is 84. Historically, stocks with a price-to-earnings ratio of over 20 don’t perform above average. Currently the S&P 500-tracking SPDR S&P500 exchange-traded fund has a multiple of about 15.5.

Buying a stock because you have familiarity with the name of the company and enjoy the products is a terrific way to get your head handed to you.

Investments are based on numbers. At the end of the day the only thing that goes into a bank account is profits. Without profits, there is nothing. Amazon doesn’t have any profits, and there is little to demonstrate the situation will change any time soon.

No profits? How can you say “no profits” when Amazon’s net was $631 million in 2011 and over a billion dollars in 2010? We can all agree a billion dollars is a lot of money, and if it wasn’t for the fact the profit pie gets sliced up into 450 million pieces, I may have a (slightly) different viewpoint.

After dividing up the profit with all 450 million shares, each share is left with $1.39 in earnings for 2011. At a price of $216 per share, it will take 155 years’ worth of 2011’s earnings to pay for one share of Amazon. The price-to-earnings number of 84 I started the article with is the forward earnings, assuming profit improves.

Amazon bulls are quick to point out how quickly Amazon is growing the top line. Amazon’s revenue was $24.5 billion in 2009, $34.2 billion in 2010, and finally $48 billion in the last reporting year 2011. Amazon, to the delight of the market, has sacrificed profits in the name of revenue growth.

The only reason why the market has put up with this Land of Oz is because investors have convinced themselves the man behind the curtain doesn’t matter. At some point, maybe an earnings release or news of a shifting in strategy by a crucial partner will turn the lights on and illuminate the fact that a lot of revenue doesn’t have to mean a lot of income.

Mall of Amazon

In many ways, Amazon is no different from the local shopping mall. There are a host of stores within the Amazon shopping experience all tied together by an Ethernet cable connecting to Amazon’s payment system. Merchants pay “rent” based largely on sales and merchants compete in a race to the bottom of price. Amazon makes money regardless of how well the merchants fare because Amazon takes a cut of the total sale and not of the profit. As a result of the commission structure, some products are better suited than others for inclusion into Amazon. The limiting nature of types of products puts Amazon at a slight competitive disadvantage.

Consumers love one place to shop and the trust that comes along with purchasing products at Amazon; however, there are others in the "trusted" Internet shopping space. Ebay, Yahoo Shopping, Apple iTunes, Barnes & Noble, Wal-Mart Stores, and others are not making life easy for Amazon.


In my experience, I have found many of the same merchants on Amazon are also on eBay and have their own website either within a Yahoo store or including a Yahoo store. What the multiple-channel sales approach by merchants demonstrates is Amazon is only as strong as the next profitable sale it brings to merchants who line up against other merchants for a “lowest price takes all” chance to make a sale. Amazon is already “expensive” in many areas from a merchant point of view.

Merchants have all the incentive in the world after they gain a new customer to bring the customer back to the merchant website and not to their Amazon store due to “inventory” costs. In a direct blow to the Mall of Amazon, Google announced last week it is raising the stakes of e-commerce with a customer service certification service. Google named the service “Google Trusted Stores” and as momentous and successful at executing as Google is, Amazon should be worried.

As physical delivery of content moves to digital delivery, Amazon will lose another competitive advantage; its superior logistics ability. Anyone can sell an online e-book, and the ability to margin a commodity item like an ordinary digital download will not be easy. Increased margins are exactly what Amazon needs to justify the lofty stock price.

Efficiency can’t carry the day for Amazon because Apple, Barnes & Noble, Yahoo Shopping merchants, Wal-Mart, and others will keep it from happening. The transaction costs are only pennies. Zero barrier of entry is why working at McDonald’s doesn’t pay well and why Amazon will face a hurricane headwind trying to increase margins. Even Netflix might figure out how to sell products online, and it has tens of millions of monthly visitors.

Amazon’s Web Services is another example of an exceptional product offering by Amazon. But how is Amazon going to profit from it? AWS and Microsoft’s Azure are currently in a pricing battle for market share.

There is no way Amazon can have a pricing war with Microsoft and expect to grow margins at the same time. I like to think anything is possible, but unless Microsoft backs down, I believe Amazon’s margins will remain under pressure. Plus, we are talking about web hosting; there are a lot of extremely skilled players in this space. Even with Microsoft out of the picture, the competition is intense.

Microsoft, Google, Apple, and Wal-Mart offer a much better risk vs. reward compared to Amazon. Every stock faces a risk of crash; however, Amazon is more of a “when” than “if,” especially at a multiple of 84.

—By Robert Weinstein, Contributor,

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TheStreet’s editorial policy prohibits staff editors, reporters, and analysts from holding positions in any individual stocks. At the time of publication, Robert Weinstein had no positions in any of the stocks mentioned.