Before you buy: Things to think about before investing in Amazon.com

A parcel moves on the conveyor belt at Amazon's logistics centre in Graben in this file photoOne of the biggest stories of the last few years has been the worldwide explosion of online retailing. According to data from Goldman Sachs, global online retail sales grew by 19% year-on-year in 2011, 21% in 2012, and 17% in 2013. In the U.S., online sales now account for more than 11% of total retail sales (excluding groceries), and the double-digit growth the sector has experienced doesn’t seem to be slowing.

The growth of online retail has, naturally, created winners and losers. Among the losers are many of the world’s biggest retailers, which have been slow to respond to changing realities. Giant American retailers like Wal-Mart and Target are struggling to grow in the new environment – Wal-Mart is expected to grow revenues by just 2% in 2014, despite its focus on building a network in emerging markets, and Target will likely grow sales by a mere 1% as it tries to deal with the fallout of a major data breach.

One of the biggest winners of the switch to online shopping has been Amazon.com. Amazon got its start as an online bookseller, and still does a good business in books, especially since it basically invented the e-book and e-reader with its Kindle offerings. But over the years, Amazon morphed beyond a bookseller, into a general retailer selling everything from clothing to electronics to gag gifts and fruit baskets. Amazon today is the world’s biggest online retailer, and is constantly adding to its offerings to maintain that position.  

Its share price reflects this evolution (see chart below). From humble beginnings at $1.50 a share and a post-dot.com-boom slump, Amazon stock trades at over $350 a share today. Although the price has slumped recently (along with many others as the S&P has experienced a correction), Amazon is still an exciting investment proposition. Today, we’re going to look at some things to consider before investing in the online giant (remember, South Africans can trade in global stocks like Amazon, if they have an appetite for it).

1. Amazon prioritises sales and operating cash flow, not profits

This is a key consideration for anyone pondering buying Amazon – the company typically focuses on growing the top and not the bottom line. It has grown revenues rapidly – sales were up 20% quarter-on-quarter in the fourth quarter last year, and up almost 22% year-on-year – and has done a good job of managing its cash-flows, which is always a key challenge for a retailer. However, its margins have always been thin, it delivered an operating margin of just 1.9% in the fourth quarter, and its average operating margin is about 1%.

In other words, right now, Amazon is focused on financing its growth with cash flows and on grabbing market share. Profitability is a secondary concern, and dividends are a distant prospect. So only invest in Amazon if you’re willing to wait a few years to see your investment start yielding dividends.

2. Amazon is experimenting with many new and potentially lucrative services

While Amazon’s main business remains selling people stuff that it ships to their houses, Amazon is doing a lot of other things too. It is becoming a major supplier of media content; members of its Amazon Prime club (who pay an annual fee that is likely to be raised soon) can stream a variety of TV shows and films from Amazon’s digital content library, and Amazon is investing heavily in acquiring new content, clearly hoping to eat into Netflix’s lucrative streaming content business. It’s even started producing its own TV shows that are exclusively available to Prime members.

The company is also moving into the challenging online grocery space. In the compact and well-networked UK, many people order their groceries online from retailers like Waitrose or M&S. But in the sprawling U.S., most grocery shopping is still done the old-fashioned way. However, Amazon is rolling out a new grocery service called Amazon Fresh. Currently available only in Seattle, San Francisco and LA, Fresh holds a lot of promise as a real competitor in the online grocery space. Amazon is also offering a lot of interesting web services, such as website hosting and renting out server space for data processing or storage.

All of these expanded offerings could spell improved profitability for the online giant in the future.

3. Amazon has a lot of room to grow globally

Amazon’s main business is still in the U.S., but there is a lot of room for the company to expand abroad. Emerging markets, which are at the start of their online shopping revolution, are an intriguing opportunity, as are the many developed markets in which online retailing is still taking hold. Amazon will keep growing in America as people switch from brick-and-mortar to online shopping, but other countries can also provide strong top-line growth.

All of these trends suggest that the Amazon success story could become stronger over time, with robust growth and greater profitability on the back of new services, products, and markets. If nothing else, it’s worth thinking about.

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Felicity Duncan is a Fulbright Award winner who worked for years with fellow Biznews editors Alec Hogg and Jackie Cameron. She is a freelance journalist.