Amazon Never Makes Money But No One Cares

Alright, technically the title’s not all true. The company made money last year, lost it the previous year, and made it the year before that. It appears that profitable years will continue their trend of outnumbering the losing ones, but it took a while get to this point, and Amazon (Nasdaq: AMZN) was still in the red for its history until 2009.

The world’s largest online store is a lasting testament to the slow-burn model of sustaining a business, the idea that maybe it makes sense to proceed methodically when your competitors are going out of their way to burn through the short term (and, not coincidentally, their cash.) Hindsight might dim the details of this, but around the turn of the century, the market had extremely strong, volatile, and often contradictory opinions of companies whose primary venue of business was this mysterious new construct called the Internet. Books, you say? That I select and pay for via my computer? And then receive through the mail? Okay, sounds suspicious, but I’m willing to give it a shot. (Perhaps this was long enough ago that we need to mention that once upon a time Amazon sold only books – durable, high-margin items that were easy to ship.)

The expression “Internet retailer” sounds impossibly quaint in 2014, like “digital camera” or “aircraft flight,” but during Amazon’s nascence it was revolutionary. As an Internet retailer that specialized in a particular good, Amazon was the contemporary of other companies that are today long defunct but in the late ‘90s-early ‘00s seemed no less viable than Amazon itself – historical footnotes such as eToys; Pets.com; and Webvan (a company that not only offered to beat other retailers’ grocery prices, but would deliver to your door without charging a fee). Back then, balance sheet fundamentals were almost a distraction, something for analysts to downplay if not completely ignore.

Which can’t possibly fly in the long term. Amazon founder and CEO Jeff Bezos understood (and understands) a lot of things intuitively, not the least of which was that sooner or later, Wall Street is going to come to its senses and realize that these prices that are detached from reality cannot be sustained. Investors are going to want tangible results, proof of a company’s viability.

Amazon was founded in 1994, first traded publicly in 1997, and didn’t turn a profit until 2001. Four years of losses are an eon for any company, especially an upstart, and especially one with such grand ambitions. Amazon lost a staggering amount of money while building its brand and grasping market share, putting itself in a position where it would eventually dominate. The company lost several billion dollars its first few years, money that very few people thought would ever be recouped. Here are the company’s annual net income numbers:

Add it all up, and Amazon’s profits for its entire existence are still less than what ExxonMobil (NYSE:XOM) takes home every 2.5 weeks. Amazon’s investors and lenders had uncommon patience early in the company’s public trading history, as Bezos and his executive team managed to convince them that not only was Amazon viable, but pioneering. Investor sentiment being what it was, the stock jumped capriciously. If you’d bought Amazon stock in June of 1997 and held it for 22 months, you would have turned $1,000 into $68,913. If you’d bought Amazon stock in Dec. of 1999 and held it for 22 months, you’d have turned $1,000 into $56. And if you’d invested aggressively then, doubling down on Amazon instead of cutting your losses, and bought $1,000 more, you’d be sitting on $62,229 today. Excluding dividends, and there’s a good reason for doing so.

Amazon has never paid a dividend. But not because the company is amassing a giant hoard of cash, like Apple (Nasdaq:AAPL) famously does. Even today, having turned the corner, Amazon isn’t really that profitable in relation to its revenue. Its profit margin for the last quarter was less than 1%. Retail profit margins are traditionally lower than those in other industries, but still, a sub-1% margin is remarkable. Why is it so low, and is this by design?

Because, and yes. As large as Amazon’s market share is, it still isn’t enough for management. The idea is to become the definitive place to buy just about everything, and to accomplish that, Amazon must compete on price – to the point where the company even tries to eradicate its inherent disadvantage over neighborhood retailers by offering unlimited shipping for a flat annual rate. Amazon might not get you your cleaning supplies or automotive accessories as quickly as the nearby drugstore or aftermarket shop can, but would you be willing to wait a couple of days if it meant not having to leave your keyboard? And what if Amazon threw in extras that no competitor can touch? (The company’s flat-rate shipping service, Amazon Prime, allows digital streaming of select movies and TV shows – something Walgreens and AutoZone [NYSE:AZO] would obviously have a hard time replicating.)

The Bottom Line

With famously receptive customer service, an easily navigable storefront, and selection the vastness of which is hard to describe, Amazon does everything possible to maintain and increase its ranks of happy customers. Investors have responded in kind, bidding the stock up to enormous levels – currently in the neighborhood of 630 times earnings. Such a P/E ratio is hard if not impossible to keep at that size in the long run, but it does speak to the market’s belief in Amazon’s business model – get as many customers as possible, satisfy them as much as possible, let the virtuous circle continue, profit (however modestly). Or as Bezos himself puts it, “Proactively delighting customers earns trust, which earns more business from those customers, even in new business arenas. Take a long-term view, and the interests of customers and shareholders align.”