First off, a quick quiz. Are these quotes about Amazon or professional wrestling?
“You have to grab your competition by the throat and you gotta squeeze the life out of your competition.”
“There has to be a business, and the business has to make sense, but that’s not why you do it. You do it because you have something meaningful that motivates you”
” ‘Exciting’ is a dull world to describe the business”
“All businesses need to be young forever. If your customer base ages with you, you’re Woolworth’s”
“That is not innovative. That is old school.”
There has been a lot of focus on the rapid decline in Q1 EPS estimates for the S&P 500, which are down 3% year-to-date. This is a discontinuous series, where the estimate always jumps at the beginning of the year. While this does not invalidate the decline that we have seen, it serves as a reminder that the best way to view EPS Momentum is using a blended forward rate.
What the quarterly data does show is that the disconnect between companies beating expectations and the subsequent revision to earnings is growing wider, making ever more meaningless the analysis of the number of company beats. There is a great game going on out there, which everybody knows is rigged, but continues to watch for entertainment, or perhaps an absence of other things to do. A bit like the fans of WWE.
The game is simple and starts with companies guiding analysts lower during a quarter. Once this is done to sufficient a degree, the company is able to beat the new estimate, although at the same time issues a warning that things cannot continue to be so rosy. Take Amazon last night, which rallied hard in extended trading because it had turned a profit. At the same time it issued guidance that Q1 sales would be in a range entirely below the prevailing estimate of $23bn and that operating profit was likely to be a loss, although it might squeak a profit, but that this would be below last year’s Q1 number.
Amazon discovered a while back that there is little to lose in not making an acceptable return on equity. It was 2010 when it last delivered a return above the cost of capital, since when the shares have still beaten the market, although not the retailing industry.
Amazon excuses its impending Q1 loss by saying that this is due to stock based compensation charges, which are non cash. However, they are still expenses and dilute existing shareholders and so must be accounted. I know that champions of the stock, and there are a lot when you trade on 527x forward earnings, will say that this is an old complaint and about as useful as pointing out that Brock Lesnar may not be the best fighter in the world. However, the point of this post is not to add unnecessarily to the for and against debate about Amazon, but to highlight that analysing stock prices against the trend in forward earnings is the most valuable means of assessing sentiment and the likely response to news.
We started off using this analysis for stocks with stable growth, such as consumer staples businesses and other such defensive companies. The assumption was that it would not work for stocks where the earnings potential was not measurable, such as an oil wildcatter for example. Amazon is a retail wildcatter, forever pursuing an even bigger opportunity funded out of today’s cash flow (and $5.2bn of financing in 2014). Over the long run the steady progress of the share price bears little resemblance to the exultation and depression reflected in analysts’ estimates, but a funny thing has happened over the last year.
We used a similar chart to show that Apple needed to pull another rabbit out of the hat with its recent results in order to justify the run up in the share price. Apple duly did and both the price and the forward estimate have gone vertical.
The question for consideration is whether Amazon turning a temporary profit is a rabbit from the hat and OTAS clients will be able to track EPS Momentum closely over the next few days to see how analysts respond to yesterday’s numbers. Meanwhile the bears can point out that over the last year, Amazon has underperformed Home Depot, Lowe’s, Target, TJX, Netflix and Macy’s by between 22% and 66%, while probably generating more column inches than all of the rest of the retailing industry put together. So maybe generating a decent return matters after all.
Bulls of the stock can point out that while WWE may be even more popular than Amazon Prime, at least that is one share that Amazon outperformed.
Wrestling – Vincent K McMahon
Amazon – Jeff Bezos
Wrestling – Alexander ‘Saint Alex’ Nderitu
Amazon – Jeff Bezos
Amazon – Dean Starkman, Columbia Journalism Review, writing about Amazon’s tax strategy