Two days ago, after UPS (UPS) beat earnings expectations, I wrote an article that suggested buying Amazon (AMZN) ahead of earnings. I was pleased to see the massive beat that they reported yesterday, but when that is combined with some other news from yesterday, it is clear that you should hang on to at least some of that stock for the long term.
Earnings dominated yesterday’s news, with well over three hundred public companies reporting their results for the third quarter. There can be no doubt as to the big winners in earnings yesterday. Two other giant U.S. tech companies, Alphabet (GOOG: GOOGL) and Microsoft (MSFT) joined Amazon in beating expectations by wide margins, but there were plenty of other stories to consider.
We heard that CVS (CVS) is trying to buy health insurer Aetna (AET) in a reportedly $66 billion deal, and department store JC Penney (JCP) released yet another gloomy outlook.
There was a flood of seemingly unrelated news from multiple sources, but those stories can all be connected through Amazon.
The most obvious connection is that between Amazon and the two companies whose main business is retail, CVS and JCP. There is a common narrative that says that Amazon is destroying traditional retail right now, but that is not strictly accurate. They are dominant in e-commerce for sure, but still only account for a small percentage of total U.S. retail sales, and are significantly smaller in that regard than somebody like Wal-Mart (WMT).
What is really causing ructions is not Amazon’s current market share, but fear of what is to come.
The move by CVS, for example, could be just another example of consolidation by vertical integration that has become all the rage in the healthcare market rather than as having anything to do with Amazon. The healthcare system in the U.S. leads the world by far in terms of costs and yet is way down the list in terms of outcomes, and that has been the case for decades, so something has to change.
Consolidation is, according to the companies involved, a way of improving efficiency and the patient experience, although more cynical minds may look at it as an attempt to become too big to fail before the finger of blame points in their direction.
Merging CVS, who started as a retail company but is already involved in service delivery (Minute Clinics) and pharmacy benefit management, with an insurer makes sense on several levels not related to Amazon. However, it cannot be a coincidence that the idea is floated as it becomes increasingly clear that Bezos et al are about to get into the retail pharmacy business.
What is driving things here is not Amazon’s current presence or market share, but fear of what they may and could do to profitability.
That fear is justified. What Amazon has shown in the past is that they are quite prepared to operate on razor-thin margins to fund growth, and that the market is quite happy with that situation. The operating margin of under 1% that Amazon “achieved” this quarter would sink many other stocks, even in growth-oriented companies, but Amazon is, rightfully, given a pass on that by investors.
I have pointed out before that what many miss when they talk about the so called “Amazon model,” where profits don’t matter and growth is pursued constantly, is that Amazon has shown in the past that they can turn on the profit tap, seemingly at will. From 2007-2010, as the recession hit retail hard, they more than doubled their profits before going back to massive investment and often losses in the following years.
That ability makes growth at Amazon even more valuable.
I cannot say that their impressive report came as a surprise, as is obvious from the above referenced article. What did, though, was the extent to which nearly every corporate news story that broke yesterday is connected to Amazon’s performance and growth. Some might argue that ultimately that will not prove to be healthy, but what it says right now is that AMZN still has a lot more upside, and that yesterday’s jump in the stock is just the beginning.