A Lumpy but Revealing Metric
Amazon shares are now trading around $138, a steep 54 times forward earnings. By comparison, other companies in the S&P 500 are trading at about a 20 multiple. So, it's understandable that investors might get sticker shock. But valuing Amazon is tricky because the company emphasizes free cash flow in its operations, along with more standard metrics such as earnings per share.
Free cash flow -- the amount of cash a company throws off after covering the costs of running the business -- is often much lumpier than generally accepted earnings measures, which smooth out components like depreciation costs. But the metric is closely watched by legendary investors such as Warren Buffett, who consider it a revealing gauge of a company's health.
And Amazon shares seem much more reasonably priced using this measure. The stock trades at between 20 and 25 times free cash flow. That's in line with the prices of other retailers, despite Amazon's much stronger growth potential, according to Citigroup (C) analyst Mark Mahaney. He points to the copious free cash flow as the "real valuation support" for the stock, and he has a $170 price target on it.
How Long Can Bezos Keep it Up?
But while Amazon's financial metrics are frequently dissected, investing in the company may ultimately be a bet on CEO Jeff Bezos's ability to keep it growing at a blistering pace. According to Citigroup's "Double-Double" thesis, for example, the online retail sales -- currently at 7% of total retail sales -- could double over the next 10 years, and Amazon's portion of these sales could also double, to 20%.
Bezos seems well aware of the massive expectations riding on him and is notable for his focus on the long term. Most CEOs seem revved up for their quarterly earnings calls, seeing them as opportunities to spin investors and manage Wall Street's expectations. But Amazon's quarterly earnings calls are generally dry affairs, often with only limited participation from Bezos.
"I always tell people, if we have a good quarter it's because of the work we did three, four and five years ago," he said in a recent interview with Newsweek magazine. "It's not because we did a good job this quarter."
As Amazon braces for increased competition with the likes of Wal-Mart Stores (WMT) and Apple (AAPL), Bezos will have a lot of that long-term planning to do. But investors considering a bet on Amazon should look beyond just a few numbers like this year's anticipated earnings when gauging the company's odds of success.
