Amazon Profits a Worry Despite Sales Growth

This time around financial results are more relevant. A decade ago Amazon hadn't sold more than $1 billion worth of goods in a single year and hadn't yet produced a profit. Last year sales swelled 39% to $14.8 billion. Profits jumped 150% to $476 million. Sales growth was robust in North America and outside of it, for company-sold goods and third-party ones, and across Amazon's three major product categories for reporting purposes: media, electronics and other. The percent increase in sales was the company's largest since 2000. That helped earn it a spot recently on SmartMoney's Accelerating Sales Growth screen.

Despite the quickening growth, the stock's current price might be too ambitious. More on that in a moment.

Once primarily a bookseller, Amazon today offers "earth's biggest selection" of consumer goods. It has a history of spending profits on product additions and web site improvements. Last year the company introduced Kindle, a handheld book reader that offers instant, wireless downloads. It expanded its music download service to include the four largest record labels. (Songs are priced the same or cheaper than those offered through Apple's (AAPL) iTunes service, but can be played on any device.) And it introduced Fulfillment by Amazon, whereby third-party sellers rely on Amazon to stock and ship their goods.

These last two items aren't flattering margins. The company turned just 20.6 cents of each sales dollar into gross profit in its fourth quarter, vs. 21.3 cents a year ago. Wal-Mart Stores (WMT), by comparison, cleared 24.3 cents of operating profit on each sales dollar in its fiscal year ended Jan. 31. Therein lies the chief concern for Amazon shareholders. Online shoppers are believed to be more fickle than ones who visit physical stores, whether it's because stores can better differentiate themselves with ambience or because more effort is needed to turn down a deal at one and seek better prices across town. Many online shoppers use "price engines," which automatically rank Internet stores according to their prices on particular items and allow users to click through for the best deal. And so hitting sales targets, for online sellers, is as easy as lowering prices late in the quarter.

Amazon says sales will grow 26% to 33% in 2008, which should be easily achievable with the right prices. But it also says operating profit will grow 20% to 50% — a wide range, but one that implies profits will grow faster than sales. That might prove tricky. A further expansion of Fulfillment by Amazon might help, since the benefits of the program, analysts say, depend on scale. But a greater mix of low-margin music downloads will at the same time work to crimp overall profitability. If overall consumer spending proves soft in 2008, Amazon might have to resort to more last-minute discounting to hit sales targets, which could mean forsaking profit targets. Over the past four quarters, the company has found it increasingly difficult to impress Wall Street's seers. Last year Amazon's profits beat expectations by 73% in the first quarter, and then by gradually decreasing amounts ending with a mere match in the fourth quarter.

All this isn't to make light of Amazon's appeal among customers, and its financial success. If it meets forecasts this year, profits will grow 38%. But shares, even after falling from $100 in October to $73 today, fetch 66 times last year's profits. That's four times the broad market's price. It's a valuation that seems to reflect every morsel of potential good news in 2008, and not much of potential challenges.

Seven other companies survived our search for snowballing sales. Most appear cheaper than Amazon. Have a look, or run the screen yourself using SmartMoney's stock screener and the full list of search criteria.