Buy, Sell or Hold: Amazon Stock is Positioned as a Long-Term Winner

If you still look at Amazon Inc. (AMZN) as just an Internet retailing giant, you're not just missing the point - you are also missing one of the really great long-term profit plays in the market today.

Amazon remains the proverbial 800-pound gorilla in the online retailing space. And business is both healthy and growing. But the company is counting on a whole new series of technology-based ventures that will provide the real fuel that will put this stock into orbit. Let's take a closer look.

Just last Thursday, in yet another positive "surprise" that Wall Street missed predicting, Amazon annihilated analysts' earnings estimates by announcing a big jump in fourth-quarter profits and told investors even better days are ahead.

Fourth-Quarter Fireworks

In a financial-crisis environment in which there is supposedly no financing available, in which massive job cuts and huge job worries are causing consumers to cut way back on their spending, in which all retailers - even vaunted discounter Wal-Mart Stores Inc. (NYSE: WMT) - face huge challenges, Amazon actually increased its sales and profits.

In fact, Amazon's fourth-quarter net income rose a hefty 9%. And not only did its per-share earnings of 52 cents blast through the Wall Street consensus of 39 cents by a full 33%, the company actually boosted its first-quarter outlook, stating that it expected sales to be stronger than analysts were predicting.

For the fourth quarter, Amazon's sales advanced 18%, beating analysts' expectations by about 4%. Sales actually would have grown by 24%, were it not for the strengthening of the U.S. dollar.

International sales were even stronger, and now account for a full 45% of Amazon's overall sales.  One notable category was electronics and general merchandize advanced 31%, and that category now accounts for 43% of worldwide sales. 

One particularly noteworthy achievement was in the area of gross margins, which suffered almost no damage - in spite of a U.S. recession that's forcing most retailers to discount heavily. Amazon's gross margins barely budged, dropping from a fairly remarkable 20.6% to a still-enviable 20.1%. 

Remember, this outlook and performance is taking place in a market environment where there's very little "visibility" - meaning company executives have almost no ability to predict what the market will look like next month, let alone in the next quarter or for next year. That's forced a lot of companies to discount heavily, and is a key reason that a large number of firms have stopped issuing "forward guidance."

But not Amazon: It continues to provide guidance - and then to exceed those expectations.

How is the company making this happen? These results point to strong market-share gains for Amazon and to new lines of business being introduced, which are powering the stock higher.  But, before we go deeper into Amazon, let's consider the economic backdrop, in order to fully appreciate magnitude of Amazon's accomplishments.

Anatomy of a Meltdown

In my 25-year investment career, I have seen countrywide market meltdowns like the one we're struggling through perhaps every two or three years.  The hallmark of these crises has been an implosion of the banking system, which has then brought the entire economy down, as well.

In an effort to provide some context - and perhaps some reassurance to U.S. investors - let me say that I've seen much worse than what we are seeing in the United States right now. For instance, there are actually cases where all of a country's banking deposits are either frozen (Argentina 2002) or lost outright (Russia 1998).

In each of those cases, there were two constants:

  • From a business standpoint, the strong got stronger as their weaker rivals foundered and failed, allowing them to pick up market share and sometimes to even buy those smaller or weaker rivals.
  • From a stock-market-valuation standpoint, however, the strong were initially equally punished in terms of their market valuations as the broader equity markets blew up, meaning their valuations didn't reflect the much-brighter outlooks for them as stronger market leaders. However, when the market outlook brightened, those stronger firms saw their valuations surge with a vengeance and soar to new heights.

The lesson from each of those crises - from Brazil and Argentina, to more than 10 countries in Asia and in Russia - was that every single country made it back.
This was even true for those countries shackled with inferior policy mixes.  Some might say that Japan - with its "lost decade" - never came back.  This would be an imprecise statement, since Japan's gross domestic product (GDP) growth was above 2.0% for the two years prior to the crisis and unemployment for the last five years has been between 3.45 % and 4.5%
But what is true is that while even countries with inferior policy mixes eventually made it back, it took a lot longer for that to happen. The speed of their comebacks can be traced to the degree in which the policies implemented made them:

  • Open-market oriented, especially with regards to foreign capital.
  • A lower-taxation environment.
  • Strongly fiscally disciplined - for the long term - because the governing body addressed such serious structural economic problems as imbalances in both the social security and health-care systems.
  • Less constricted by regulation.
  • More transparent, in both the private and public sectors, especially in cases where the public sector overhauls led to a more democratic governing process.
  • More-consensus oriented, particularly when that consensus included support for all the changes I've listed here.

While we are not seeing an unequivocal embrace of these tried-and-true recipes by the newly installed Barack Obama administration, mainly because of a bias toward big government, we are seeing an open-minded attitude and some movement in this direction.  And we will have to monitor this closely, because history shows us repeatedly that there are no half measures when it comes to successful economic and financial reform - and because market investors know this and will therefore be watching closely.

Forewarned is Forearmed ...and Other Axioms to Live By

This background is important, for we now know that we can expect to see some once-in-a-generation buying opportunities in companies that can navigate this slowdown and position themselves for a massive subsequent rebound.

We also have to remember that his rebound won't be immediate. But when it does come, that rebound will be huge for the companies that have used this time to buttress their already-leading market position. They've capitalized on consolidations in their respective industries or market sectors, and have certainly grabbed market share away from their rivals. The maximum gains will be realized only if financial prudence prevails in the public sector.

Is that happening here in the U.S. market?

Well, we're about to pass a huge stimulus - perhaps as much as $1 trillion or more, when all is said and done.

There's an old axiom about government stimulus packages: When money is spent, the economy grows. The key, however, is at what cost and who pays for it. So the short-term "steroids" effect of the stimulus has to be measured against the long-term weight its costs will exert of future growth.  But, ahead of that steroids injection, investors need to invest in the beneficiaries.
A much-repeated market axiom states that  "no one buys at the bottom, and no one sells at the top." Much like no one was - or will be - ringing a warning bell at the market bottom, no one was ringing a bell at the top a year and half ago.  And nobody will be letting you know which of these companies will be thriving and which will be vanishing - because the investors who understand all this are very busy accumulating them for themselves right now.

So it is no surprise that Wall Street missed by a mile on iconic companies that are thriving, including International Business Machines Corp. (NYSE: IBM), Apple Inc. (Nasdaq: AAPL), United States Steel (NYSE: X), PMC-Sierra Inc. (Nasdaq: PMCS), Level 3 Communications Inc. (Nasdaq: LVLT), 3M Corp. (NYSE: MMM), Colgate-Palmolive Co. (NYSE: CL), Automatic Data Processing Inc. (NYSE: ADP), United Parcel Service Inc. (NYSE: UPS), Merck & Co. Inc. (NYSE: MRK), and many others.  And Wall Street always seems to miss to the downside in its estimates in these superb companies.

In the same way, Wall Street missed it with Amazon.  You see, Amazon survived the dot-com bubble because, unlike most of the start-ups, Amazon actually had a strong-and-viable business model.  In addition, starting with founder and chairman, Jeffrey P. Bezos, and continuing down through the rest of the organization, Amazon has in place a superb management team that has continued to carefully refine and build upon the company's original vision, and has continued to execute almost flawlessly.

It's not just the great value, convenience and solid customer service that contribute to Amazon's results - it's also innovation.

Those "Killer Apps" - "Cloud Computing" and the Kindle

Amazon first revolutionized the bookstore business. Then it revolutionized overall retailing. Now it's aiming at the book-publishing business with its super-lightweight electronic reading device - called the Kindle. The Kindle allows you to buy and download books in less than a minute - from almost anywhere - without the need to connect to a computer or any device. Lots of books are available.

This is all possible because you are using the fastest wireless standard and the service is included in the price of the book you downloaded. And Kindle can hold some 200 books, newspapers and blogs and has free wireless access to Wikipedia.  The newspapers and blogs are downloaded automatically and updated instantaneously.  Kindle recharges in less than two hours and you can also email your own Word documents and pictures.

With all these features, I am seriously considering buying one. Here's why:

  • It will eliminate the need to walk down my long driveway to grab my copy of The Wall Street Journal every morning.
  • It will be much easier to read than in my PC.
  • All my downloads will stored in Amazon's servers, just in case I lose or damage my Kindle.
  • And it will save me countless trips to the library to pick up books for myself, and for my avid-reader daughters.

However, I'm going to wait until after Monday (Feb. 9), because Amazon has invited the news media to an event it has planned for the Morgan Library & Museum in New York City. The scuttlebutt is that Amazon could be announcing the "Kindle 2.0."

By saving trees (reducing the need for paper) and eliminating the costs for printing, storage and delivery, publishers can reduce their costs considerably and pass part of those savings on to the consumer.  Therefore, the typical book will cost you $10 or less.  And you can even get some steals, like all sixteen novels by Charles Dickens in a single file, with an active table of contents - all for only 99 cents!

It's incredible.  No wonder Kindle is expanding sales and margins for Amazon.

But Amazon's "miracle" performance is not due just to the Kindle.  Amazon has jumped in on the fast-growing trend of "cloud computing."  Now that the Internet has become ultra-fast, and is getting even faster - thanks to such hyper-fast, high-speed fiber-optic networks as the Verizon Communications Inc. (NYSE: VZ) FiOS broadband system - the balance has shifted towards centralized computing. 

What this means is that with a relatively cheap computer and fast Internet access, one can perform most of the computational activities in the servers of somebody else.  So, somebody else will host the applications, store the data and perform the computation - for a fee, as it is accessed via the Internet.

Therefore, the need to maintain the storage and back it up, to keep your systems up to date and even to help prevent viruses is essentially transferred to the supplier of the service. This is especially important for individual users and small- and medium-businesses, which look to minimize all these costs.  But it is also very useful for some large enterprises in services where Amazon's scale and expertise can deliver superior cost-savings and reliability.

Amazon aims to be a major player in this realm. Indeed, some analysts believe this could one day be the "real" Amazon business, with books and other retail goods serving only to bring folks in the door.

Amazon already provides storage, virtual private servers, elastic cloud computing, which gives developers a resizable capacity, content delivery and a number of other functions through its fast-growing cloud-computing activities.

This cloud-computing trend has also been embraced by Google Inc. (Nasdaq: GOOG), though Google Apps, and Yahoo! Inc. (Nasdaq: YHOO), which has forced Microsoft Corp. (Nasdaq: MSFT), which is built on the premise of distributed computing, to hedge by planning to offer a cloud computing operating system.  The new operating system will enable net books (barebones notebooks), PDAs and other smartphones to take full advantage of sophisticated computing capabilities and massive storage located in the "cloud."

Clearly, cloud computing will be an explosive business, especially in Amazon's focus areas of storage, content distributions and scalable computational capacity. 

So, with book sales, electronics and its international efforts already strong and accelerating, and the probability of a Kindle 2.0 announcement now imminent, we need to jump on Amazon, while planning to keep the stock for several years.

Rocking With Retailing

Is this consistent with a sound investment strategy for retailing stocks in the current weak-economy market environment?

I recently saw a noted short-seller, who runs a very successful hedge fund (and you have to be good to be still alive), who indicated that for the first time in a long time, he saw opportunities to make money both on the long and on the short side.  This is encouraging, since for the year and a half prior to last November, the opportunities on the long side have been overwhelmed by the financial meltdown and massive de-leveraging

In addition, this hedge fund manager was asking a renowned investor in retail stocks what opportunities he saw for shorting these stocks.  The reply: You have to be very careful - even in retailers, which were experiencing big problems - because, in his opinion, valuations had fallen way too much.

I agree with both assessments. At this point, there are good opportunities to buy, and in retail you want to go with the winners.

For all the reasons we've detailed to you, Amazon is that "winner," the strong company with a rock-solid business model that delivers value to customers, that innovates, that has a clear focus on expansion, and that is producing results even in one of the worst economic periods since the Great Depression.

RecommendationBuy Amazon.com Inc. (Nasdaq: AMZN) before Monday's product announcement and ahead of the rollouts of the stimulus packages planned by both the United States and China (**).

[Editor's Note: Veteran Wall Streeter Horacio Marquez is the author of Money Morning's hugely popular "Buy, Sell or Hold" (BSH) series, and is also the editor of the longstanding "Money Moves Alert" trading service.

As the hundreds of thousands of readers across the Internet who've read Marquez's insightful BSH missives know, the longtime Wall Street insider has a knack for picking stocks that are poised to move. Indeed, when he recommended the Brazilian exchange traded fund - the iShares Brazil Index (NYSE: EWZ) - in late October, it zoomed 42% in six days.
In a new free report, Marquez has identified a category of stocks he has labeled "rocket stocks," which display key characteristics hinting that they're ready to move. One such characteristic: Heavy insider buying. In fact, one particular sector right now is seeing especially heavy insider buying - and many investors will be surprised to discover just what sector it is, and what companies top executives are buying into. For a free report that details these "rocket stock" plays, and that outlines this torrent of insider buying, please click here. The report is free of charge.]

(**) - Special Note of Disclosure: Horacio Marquez holds no interest in Amazon.com Inc.

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