Amazon Misses on Earnings Per Share, Price Drops 8%

Amazon

Most companies are coming in ahead of estimates for third quarter earnings, which is due in part to particularly understated predictions. Amazon’s wasn’t set low enough.

When your company is worth 888 billion, a single percentage point move in your stock adds up to 8.8 billion. Amazon dropped 8.75 of these when it’s third quarter earnings report hit the street right after the closing bell, which works out to a loss of $77 billion.

The miss was actually off by 8%, so at least initially, the dip in the company’s stock price and the dip in the value of the company’s stock were the same.

This in itself is pretty interesting, as it provides some insight as to just how the stock market magnifies things. The actual amount of profit that was missing from this report was $185 million, so the market saw fit to mark down the company’s value by this whopping figure of $77 billion, which works out to magnifying this shortfall by 416 times.

This is on the other end of the universe from any sort of reasonable adjustment in the present, so we know that while these things move prices, there’s a whole lot more going on with the price of a stock than its business results.

What really goes on with stock prices is the expression of the collective belief in the future price of a stock. We might think that Amazon is priced so high because of the future potential of its business, and while that does form a base for this belief, it’s more a matter how much we will magnify these future results.

When we see the price of a stock decline due to missing an earnings projection, this has far less to do with the prior quarter that the earnings are being reported in as it has to do with how it changes our belief about the future of the company, and specifically, it’s future stock price.

The more a stock’s price is about the future, the greater the effect a particular earnings report will have. Analysts use price-to-earnings ratios to value stock prices, although these ratios can vary quite a bit and the theory doesn’t do very well in explaining the value of a stock, because we’re only looking at a single earnings period and stocks are much more forward looking than that.

These ratios do tell us something useful though, as they express what additional value the market is giving a stock over and above its present performance. In other words, this ratio tells us what the market thinks of a stock’s future, and the higher the number, the more it likes it.

Some stocks don’t have a PE ratio because they don’t have earnings, and with these stocks, the future is the only thing driving them, and the present actually weighs upon that. We will tolerate a company losing money for years though as long as we see a positive enough future to have its stock price a positive number and impart positive value on a proposition that is currently negative.

Amazon is “Pricey” Beyond Belief, But This Makes Sense

This, like with higher PE ratios, show us the power of the future with stocks, even though fundamental analysts choose the much less significant present and even try to portray brighter outlooks about the future as expressed in higher ratios as a reason to not prefer them, assuming that they are overvalued.

They are overvalued from the perspective of the present, but people’s beliefs in stocks do not hit a wall in 12 months and what happens beyond that matters a lot actually, because we plan on holding it beyond this short time period.

People think that PE ratios above 20 are too high, and Amazon is a great example of how high of a PE ratio we can see when the future is seen to hold a lot of value. Companies like Microsoft and Walmart both have PE ratios of 27, but these are companies that people like going forward, over, for instance, a company with a much staler looking future.

Amazon’s PE lives in the 70’s and towers over other mega cap stocks. This is on the top floor of pricey according to the way people use this tool, where higher is pricier. Amazon is three times pricier than Walmart and Microsoft for instance, but this just means that its perceived future value is three times greater. This ends up using the word pricey in a distinct and untenable way.

We usually use it to say that something is priced more than it is worth, in various degrees of excess. If we assess a company’s worth merely on the present, and ignore its future value, it will indeed be overpriced by the premium provided by the future.

Amazon certainly is growing and have justified their higher PE ratio, even though it doesn’t really make sense to say that this would ever need to be justified. PE ratios, like stock prices, just are, as a quantification of the market’s pricing in the future with a stock.

Any Slip by Amazon Will Be Greatly Magnified

When the hill ahead is seen to be steeper, and Amazon has a very steep one laid out for them, missing a step on a steep hill will cause you to slip down further when you stumble. The miss affects the previous quarter, but that has already happened, and it is what these numbers bode for the future that matters. We’ve just shaved off some future expectations with the earnings miss, by the exact amount that the value of the stock became reduced by.

Sales were up last quarter though, so we therefore know that the shortfall had to come from increased costs. Amazon’s shipping costs have doubled year-over-year, and while this has arisen from the push toward next-day shipping, this does give us a view of what that reality will look like and what effect we may expect it will have on Amazon’s bottom line.

Amazon’s margin in the North American market has now fallen to 3% from 5.9% a year ago, and even if you sell more, you can make less if your margin is thinner.

Amazon has predicted that their fourth quarter revenue will come in between $80 and $86.5 billion, and the top end of this is below the consensus of $87.4 billion. Operating income is also expected to continue to move in the wrong direction, and both of these factors also weighed on the stock.

It very well may be that the push for faster shipping may be narrowing the gap between them and brick and mortar retailers, but we have to wonder whether the increase in the overall market share this will provide will justify lowering margins as much as it is.

The ship continues to sail on its marvelous journey, but there are some creaking sounds in the engine room now, and given how magnified these things are with Amazon, we need to be listening to the sound of the engine carefully.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.