AMZN reported 2Q15 results after the close last night. They were very good.
Sales were up 20% year-on-year; expenses rose by 17%, three percentage points less. As a result, the company reported an operating profit of $464 million vs. a loss in the second period of 2014.
More than that, AMZN’s cloud services division, AWS, had revenue growth of 81% yoy and a quintupling of segment profits (basically operating profits less stock option expense) to $391 million. AWS, broken out as a separate segment for the first time after 1Q15, remained a bit more than a third of the AMZN total.
AMZN posted an overall profit of $.19 a share for the quarter, vs. analysts’ expectations of a loss of $.13 a share and a deficit of $.27 per share in the year-ago quarter.
On the announcement, the stock immediately rose by 15% in aftermarket trading.
AMZN opened up by 20% this morning, before drifting down steadily during the day to close +9.8% in a market that was down just more than 1%.
Why the strong advance?
I have no good explanation, although I do have some ideas.
1. The obvious factor that changed overnight was the earnings announcement.
It contained a significant positive earnings surprise, one that makes it more likely that the company will earn, say, $1- a share in the current year. It makes the analyst consensus of $2.78 a share for 2016 more believable. On the other hand, the stock was trading at $482 before the earnings report, or 173x the 2016 consensus. Looking at the stock price another way, let’s say that at maturity for its businesses (whenever that may be), AMZN shares will be trading at 20x earnings. To sustain the pre-earnings report price, that would imply a burst of rapid growth that shoots earnings up to around $24 a share. That would be something like a doubling of earnings each year for the next five or six.
That’s already baked in the cake. A buyer of the stock at this level must believe that $24 a share in eventual earnings is way too low.
I find it hard to believe that a $.32 per share earnings surprise during one quarter–when expectations were already sky-high=-would be enough to add 20%, or even 10%, to AMZN’s perceived market value.
2. A second hypothesis…
What if investors are beginning to separate AMZN into two parts, AWS and everything else, and are doing a sum-of-the-parts evaluation. To me, this sounds a little more plausible. What would the numbers look like?
Let’s say that in 2016 AWS will comprise half of AMZN’s earnings and AMZN Retail the remainder. To make the figures easier, let’s say each half earns $1.50 a share next year.
Let’s assume AMZN retail can grow in earnings at 20% a year for a long time, and that we’d be willing to pay 50x current results–a big number for a retail stock–for that future profit stream. If so, AMZN Retail is worth $75. To reach a sum-of-the-parts value of $482, AWS must therefore be worth about $400, or close to 270x its 2016 eps. Ok, while I personally wouldn’t be willing to pay that much for AWS, I can see how someone else might. However, I still don’t understand why confirmation that a holder at 270x earnings isn’t insane would cause the multiple to expand. (Also, before I’d be comfortable valuing AWS as a separate company, I’d want to know more about how AMZN apportions revenues and costs among segments to ensure the published numbers don’t flatter AWS. I’d also think long and hard about the possible effect of stock options.)
3. The explanation for AMZN’s rocket ship ride that I’m leaning toward, however, is more technical. Two factors may be involved. At what Google Finance reports as 21+ million shares, today’s trading volume in AMZN was 7x normal. The sharp opening spike suggests to me that algorithmic trading computers were at work reacting to the earnings report, not humans. Humans, I think (?!?), would have a better sense of valuation. I also suspect that the report and immediate upward move triggered a lot of short covering.
I’m partial to #3 because I think the whole reaction is a little crazy.
Why is any of this important? AMZN is a high-profile, large-cap stock with almost two decades of operating history. There’s got to be a way to make money from the possibility that something like AMZN’s big move will occur with other similar names.