When I was a cub analyst at DLJ I was taught to begin a research note with three, and only three, bullet points. There is a virtue to simplicity. Amazon's (AMZN) investor relations department apparently never received such training, as last night's earnings press release contained 40 bullet points after Jeff Bezos' overview comments. That's too many individual factoids for any human to process, and that's the main problem with Amazon stock. The shares were getting clobbered in after-hours trading, losing an astounding $60 billion in market capitalization since the figures were released.
The culprit there was clearly Amazon's light guidance for fourth quarter revenues and operating profit, but the biggest worry for a long term Amazon shareholder has to be the lack of focus exemplified by those 40 bullet points. There's just so much going at Amazon. With operating income down 15% year-on-year in the third quarter and management forecasting another decline in the seasonally-important fourth quarter, one could ask the question, is there too much going on at Amazon?
I believe the answer is yes, and I believe Amazon shares will gradually lose the incredible premium that was earned in the 2015-2018 period. Analysts will be lowering EPS estimates for Amazon Friday, and I believe a significant haircut to the pre-earnings consensus EPS estimates of $23.60 for 2019 and $32.30 for 2020 is warranted. The key to AMZN's share price performance, however, will be the market's willingness to shower Bezos' company with a "growthy" multiple -- 55x 2020 EPS before the earnings report -- just as Amazon's growth rate is clearly slowing.
Amazon's net sales on a trailing 12 month (TTM) basis were $265 billion in the third quarter. That represented a 20% rate of annual growth, and of course it is much more difficult to grow against such a large base. This is where the second derivative, the inflection point, comes into play. I have mentioned that concept as crucial to profitable investing in my prior RM columns, and Amazon's TTM operating profit is a, pardon the pun, prime example of this.
Amazon's TTM operating income was $14.448 billion for the third quarter, a 34% year-on-year improvement. Amazon's third quarter-only operating income, however, was $3.157 billion, a 15% year-on-year decline. The move to one-day shipping, Amazon's huge investment in content for Prime Video, the still-puzzling decision to buy low-margin Whole Foods and slowing growth at cloud services business AWS all figure into that calculus.
Make no mistake, though. In terms of operating margin, we have seen Peak Amazon. That's what had the market so freaked out in the after-hours session, and there was nothing Bezos and his CFO Brian Olsavsky could say to soothe the market's fears on that topic.
Amazon will continue to grow revenues in future periods, of course. Those incremental revenues are, in my opinion, going to produce fewer and fewer incremental dollars of profit. That's Peak Amazon, and that's why I don't believe AMZN shares will hit $2,000 again in this business cycle. AMZN shares finished Wednesday's trading at $1,780, almost to the penny where they finished trading on October 24, 2018. The after-hours move makes AMZN a solid underperformer, though, and that's a challenge for portfolio managers. The bigger they are, the harder they fall, and those fund managers who were paying more than $2,000 for Amazon shares as recently as July must be sorely disappointed this morning. I believe that disappointment will continue, as Amazon's mission just becomes more and more difficult to summarize in one sentence--or even 40 bullet points.