Amazon - Is Disruption Worth More Than Profits?

In his latest quarterly letter to investors dated October 24th, Greenlight Capital's very successful well-known veteran hedge fund manager David Einhorn wrote the following:

"Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value," he wrote. "What if equity value has nothing to do with current or future profits and instead is derived from a company's ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?"

"Our view is that just because Amazon can disrupt somebody else's profit stream, it doesn't mean that Amazon earns that profit stream. For the moment, the market doesn't agree," he wrote. 

Einhorn's conclusion would prove to be an understatement!

Late Thursday (after the NY market closed), October 26th,  Amazon released its latest quarterly earnings report.  It reported revenue of $43.7 billion as compared to a consensus Wall Street estimate of $42.0 billion, and Amazon reported "adjusted" earnings of $0.52/share versus a consensus estimate of $0.02/share. Investors immediately piled into Amazon's stock, and Friday's 13.22% gain in Amazon's stock price is a clear testament to Einhorn's theory that value may have nothing to do with current or future profits, but may instead be derived more from a company's ability to be disruptive!

In the fine print of Amazon's earnings report, the Company reported $4.58 billion in revenue from it AWS cloud services division which translated into $1.17 billion in operating income from this division. It may be noteworthy that AWS accounts for approximately 10% of Amazon's total revenue and ALL of the Company's profit. In fact, without this $1.17 billion in net income from AWS, Amazon actually LOST $823 million for this latest quarter in all of the rest of its divisions combined!

Amazon's cloud services division currently has 30% of the cloud services market, but competitors are making up ground extremely fast. Microsoft's growth in this sector has beaten Amazon's growth for 8 quarters in a row. Microsoft is now the second largest player in this space with 14% of the total market. Other major competitors include giants like Google, IBM, Alibaba, and Oracle.

Investors now value Amazon at 278 times trailing twelve month earnings! Investors expect Amazon's "earnings" to double over the next twelve months to about $8.00/share (this looks optimistic, at best), which would then translate into a forward price/earnings ratio of about 138 times if we used Friday's closing stock price of $1,100.95/share! This compares to a forward P/E ratio of about 20x for the major market indexes.

Amazon has at least 130 major corporate competitors, mostly in low margin businesses. While all these companies attempt to adjust to Amazon's disruptive (and predatory) low price strategies, it's unclear when (or IF) Amazon will EVER earn substantial profits. Amazon's current "profit engine" is clearly its cloud services division, but given the substantial corporate names now competing aggressively in this space, investors should probably NOT count on the same kind of revenue growth or profit growth in quarters immediately ahead (or EVER) from this key division!

With respect to the broader market last week, despite record all-time highs posted this past Friday in the Nasdaq Composite Index and the S&P 500 Index, the average Nasdaq listed stock actually fell every day last week except on Friday. Even with Friday's big gain, the average Nasdaq stock still lost 0.90% on the week. On the New York Stock Exchange, the average listed stock declined 0.51% on the week!

In my computer trading system, despite record highs in the Nasdaq Composite Index AND the S&P 500 Index:

Weekly chart sell signals were officially triggered at Friday's close in the following stocks: BA, BSX, FIVE, GM, HPQ, MMC, MTH, PCH, PFE, RTN, and UTX.

Monthly chart sell signals were triggered last week in the following stocks: BIIB, BK, BMY, CVX, EBAY, GD, LMT, MMC, RTN, TWX, and UN.

Caveat Emptor: There is something terribly wrong inside the U.S. stock market, and a major correction looks highly probable on the near-term horizon!

The week ahead may prove to be among the more interesting weeks of this entire year. Here are just a few potential triggers of increased volatility:

1. Special counsel Robert Mueller's office is expected to announce its first indictments in its ongoing investigation of Russia's meddling in the November 2016 U.S. Elections (probably Monday, October 30th).

2. Congress is expected to release its first draft of potential tax reform (probably midweek - November 1st. A 1,000 pages of tax cuts (no real tax reform) and hardly any spending cuts is forecast. Current deductions for mortgage interest and State & Local taxes will probably be maintained, which would then violate the $1.5 trillion deficit cap that was agreed to in the budget reconciliation agreement).

3. President Trump is expected to announce his choice for Chairman of the Federal Reserve (unknown date, but probably towards the end of the week - the WSJ is reporting that Jerome Powell will be Trump's pick, but I continue to believe there is a chance that President Trump will choose John Taylor who would be Trump's "own guy" as opposed to an Obama holdover in Powell)

4. The Federal Open Market Committee meets to discuss monetary policy (statement expected on Wednesday, November 1st - no interest rate hike is forecast, but the closing statement will likely be hawkish and indicate that a December interest rate hike is likely along with ongoing regular monthly draw-downs of the Fed's balance sheet as per the schedule already released)

5. The Labor Department will release its latest monthly employment report  for October 2017 (this release is expected Friday morning, November 3rd).