Not only has Amazon lost billions on shipping each year, but its losses have become larger over time.  In fact, you can take many of Amazon's recent innovations (including the Kindle) and put them to the profitability test and will find them falling short. I am sure that Amazon's cheerleaders will argue that both the Prime and Kindle create synergistic benefits to Amazon, but in that argument would have resonance, if the company made money in the aggregate.

At this stage, the value of Amazon rests on how much you trust the vision that Jeff Bezos has for the company and whether you believe in his capacity to fulfill that vision. In fact, the value of Amazon will be largely determined by your assumptions about revenue growth and operating margins. To provide perspective, let’s start by looking at where Amazon falls in the competitive spectrum by looking at the retail sector as a whole. In the table below, I list the ten largest retailers in the US and globally, in terms of revenues:

Note that while Amazon makes the top ten lists in terms of revenues both in the US and globally, it lags in terms of profitability with paper-thin operating margins.  To get a measure of profitability in the retail sector, I estimated operating margins (converting leases to debt) for all retail firms and report the distribution in the graph below (for both the conventional pre-tax operating margin, which is operating income as a percent of sales, and a lease-adjusted operating income, where leases are converted to debt).

Rather than play scenario games, I chose to vary revenue growth and operating margins to see the combinations that deliver values (shaded in yellow) that exceed the current stock price ($295) in the table below:

 

I draw three lessons from this table. The first is that there are pathways that Amazon can follow that deliver values greater than $292 but they are narrow and require a combination of high revenue growth and high operating margins, and some of these combinations may expose the company to anti-trust action down the road. The second is that the variable that makes the bigger difference is the operating margin, not revenue growth. In fact, if the margin stays at 2.5%, higher revenue growth causes value to decline as the cost of increasing revenues (acquisitions and reinvestment) exceed the benefits. The breakeven operating margin at which growth even starts to create value is about 4%. and if the operating margin stays at 7.5% or lower, you cannot get above the current stock price, even with Walmart-like revenues. The third is that the potential for explosive returns is low, given the current stock price. While there are combinations of revenue/margin that deliver values well above $295, they seem improbable, requiring Amazon to have revenues like Walmart and margins like Lululemon.

 

Bottom line

In a world of cookie-cutter CEOs, uninspired and uninspiring, eager to please analysts (rather than investors) and playing the me-too game (You can buy back stock, me too! You can do acquisitions, me-too!), Jeff Bezos offers a refreshing contrast. He has a vision for Amazon, has communicated it to markets with passion and has acted consistently with that vision, and has been rewarded by markets with a high market value for his company, even in the absence of profitability. However, the peril with charismatic CEOs is that the strength and single-mindedness that make them so successful can become weaknesses, if they start believing the hype. As a consumer, I am delighted that I get Amazon Prime for $99 a year, that the Kindle costs a lot less than an iPad and that I can (though I don’t plan to) pick up the Amazon Fire for nothing, but as an investor, this is not a winning game.  Mr. Bezos has delivered on half of his field of dreams vision by building up the revenues for Amazon, but the other (and more difficult) half of the vision requires that the “profits” arrive. Much as I would like to believe in miracles, it is take far more work to make Amazon profitable than it would to make Shoeless Joe Jackson show up in a cornfield in Iowa!