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Amazon Posted Its First Profit In Months, but Stocks Fall

Jan 31 2014, 7:25am CST | by

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Amazon Posted Its First Profit In Months, but Stocks Fall
 
 

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Amazon Posted Its First Profit In Months, but Stocks Fall

Amazon posted results yesterday for its all important holiday quarter. One of the surprising things about this quarter is that Amazon posted a nice profit of $239 million, after several quarters of almost no profit or outright losses. And yet the stock was absolutely crushed, falling 10% in after-market before recovering slightly.

How come?

The results fell slightly short of expectations, but that alone doesn’t account for the swing. The bigger reason tells you how markets work. The main reason why Amazon tanked is that it posted guidance–Wall Street speak for how a company thinks it’s going to do over the next quarter–below expectations. And that makes a world of difference.

In finance theory, the value of any asset–a house or a company–is the net present value of its future cashflows. In other words, what determines what a house or a stock is worth is how much money it will make in the future. The value of a money-producing asset is equal to all of the money the asset will earn in the future (discounted to today, because a dollar today is worth more than a dollar tomorrow). The asset’s past performance is only relevant insofar as it tells you something about its future performance. This is the key thing that people always forget. It helps explain why revenue-less startups can be valued at billions of dollars, and why Apple can tank as it posts record profits, and Amazon can soar as it loses money.

Now let’s think about that within the context of Amazon. Over the past few quarters, Amazon has been losing money–and yet investors have sent the stock soaring. Why is that? If a company is losing money, it can mean several things. It can mean that its business is not working. But it can also mean that it is investing in businesses that will pay off in the future. In other words, if the company is losing money, it can mean it becomes more valuable since it means it will make more money in the future–and remember, what an asset is worth depends on the money it will make in the future.

Of course, any company that’s losing money will have a CEO saying that it’s because of “investment” and not because its business is doomed, and investors shouldn’t necessarily trust it. Why did they do it for Amazon? Because Amazon has done it before. Amazon has shown that when it invests, it generates future cash flows–when it invests, it makes the company more valuable. Amazon lost money for its first 8 years as a company. After the dotcom bubble burst, everyone thought Amazon was toast. And yet, Amazon and its CEO Jeff Bezos showed they knew how to make money. And from 2003 to now, Amazon has been minting it with its incredibly popular retail franchise.

And now Amazon is investing in new lines of business: warehouses so it can offer better shipping; Kindle devices and services; cloud computing; video streaming, and more. Remember, if a company is losing money, it could mean its business is not working–but Amazon has shown that its core retail business works. If Amazon is losing money, it means it’s investing in new lines of business. That’s never a guarantee of success, but Amazon has a great track record of making its investments pay off–and so investors are being totally rational in bidding up the stock, because it’s a very sensible bet that when Amazon invests, it is increasing its future cashflows, and therefore increasing its future value.

Now go back to yesterday’s quarter. Amazon posted okay-ish results. But that’s the past. What it said about the future is more important. It posted guidance (about the future) below expectations. It also suggested that it might raise the price of its phenomenally successful Prime two-day-shipping program. That’s also about the future.

When Amazon was losing money, there was a totally rational reason for its stock to go up. Now, Amazon might be making money, but it’s telling Wall Street the future might be less bright than it expected. It’s totally rational for the stock to drop. If you understand those reasons, it means you understand that the value of an asset depends on its future prospects, not the past. And if you’ve understand that, you’ve understood the most important thing about markets.

Source: Forbes

 

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