Does Amazon's Valuation Make Sense at These All-Time Highs?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Shares of Amazon.com jumped nearly 10% this morning as the e-tailer giant impressed with a solid third-quarter report. Amazon stock has now gained 46% year to date and 64% over the last 52 weeks, absolutely crushing the Dow Jones Industrial Average in both cases. The stock has also destroyed traditional retailers like Wal-Mart and Target in both the long and short runs.

And you know what? It all makes sense if you just let go of analysis methods that don't really apply to Amazon's business model.


Amazon still looks extremely expensive on traditional metrics like the P/E ratio (currently more than 4,000 times trailing earnings) or enterprise value to free cash flow (139 times trail ing FCF).

It's kind of a tradition for Amazon, which works in an eternal start-up mode. Whenever Amazon has cash to spare, it tends to get plowed into growing faster. Sometimes the changes drop directly into the top line as Amazon attracts new customers by lowering prices -- and profit margins. Other times, CEO Jeff Bezos invests further down the income or cash flow statements, like more shipping centers or brand new media operations. The one constant is, Amazon happily spends money today to make more of it tomorrow.

This chart looks a little scary at first, as Amazon sacrifices both cash and GAAP profits in the name of fantastic revenue growth. But one look at the green line, showing Amazon's cash balances growing over time anyhow, might settle some jumpy nerves:

AMZN Revenue (TTM) Chart

AMZN Revenue (TTM) data by YCharts

That's why Amazon shares can jump 10% despite showing a net loss in the third quarter. Analysts expected exactly the $0.09 loss per share that Amazon delivered, and the company came up big where it really matters. Yep, that's the all-important revenue line: Amazon impressed Wall Street and shareholders with 24% year-over-year sales growth, landing at $17.1 billion. Analysts would have settled for $16.8 billion.

These strong sales do more than just add to Amazon's most important metric right now. They also set the company up for a strong holiday season, assuming that the demonstrated consumer interest carries over into the next three months.

Traditional retail giants Wal-Mart and Target most certainly squeeze more profit out of their revenue streams than Amazon ever did. Amazon often runs near breakeven on the GAAP bottom line. Both Target and Wal-Mart aim for net margins between 3% and 4%. But then, the big-box retail veterans also settle for sales growth near the 3% mark while Amazon delivers more than 20% on that metric.

The low-margin strategy may sound scar,y but it hasn't stopped Amazon investors from making a killing, compared to the modest long-term gains in Target, Wal-Mart, or the Dow:

AMZN Chart

AMZN data by YCharts.

3 companies ready to rule retail
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. Amazon is a leader in the new paradigm, but not the only promising play on the table. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

The article Does Amazon's Valuation Make Sense at These All-Time Highs? originally appeared on Fool.com.

Fool contributor Anders Bylund has no position in any stocks mentioned. Check out Anders' bio and holdings or follow him on Twitter and Google+. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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