Pipe Dreams: Why Amazon Won't Deliver The Profits The Momentum Crowd Has Been Wishing For

Disclossure: I own MSFT shares; I am shortNFLX shares

Of all momentum stocks that have endured the test of time, one stands out: Amazon.com . The stock has stayed popular with the momentum crowd for more than fifteen years.

For a good reason: the company has been growing by leaps and bounds, expanding the scale and scope of its operation, both horizontally and vertically—a strategy that resembles that of Standard Oil in the late 19^th century.

The problem is that Amazon competes in a different industry, and during a different era from Standard Oil’s. And its winner take all strategy is turning costly – because a strategy like that requires a great deal of investment for warehouses, transportation gear, content acquisition and so on.

Worse, as Amazon grows into a big gorilla, it pits itself against other gorillas with deep pockets and hunger for a larger piece of the pie.

The result? Price wars in both the resource and the commodity markets the company operates, squeezing its profit margins.

In its traditional book business, Amazon pits itself against major book publishers.

In the streaming market, Amazon pits itself against Netflix —and ends up paying more for original shows. In the cloud computingmarket, Amazon pits itself against Google andMicrosoft —and ends up cutting prices.

But Amazon’s bigger problem is Wal-Mart.Early this year, Wal-Mart scored a big win against Amazon.com: Wal-Mart’s on-line sales growth outpaced the sales of Amazon.com for the period ended Dec.31.

Wal-Mart’s gains against Amazon.com follow a well-crafted strategy, which includes the acquisition of on-line search technologies and the building of warehouses. In 2013, for instance, @WalmartLabs, Wal-Mart’s e-commerce technology arm, acquired four start-ups: Torbit, a cloud-based website accelerator service; Inkiru, a predictive intelligence platform; OneOps, a cloud based automation technology; and Tasty Labs.

Currently, Wal-Mart is about to acquire Adchemy, a search engine marketer.

Amazon remains the on-line leader, beating Wal-Mart by 7-1. Nonetheless, Wal-Mart’s strategy demonstrates that Amazon doesn’t have a sustainable competitive advantage. Any retailer with deep pockets to recruit or acquire the best talent can make a foray into its markets.

And Wal-Mart isn’t just any retailer. It is the biggest retailer in the world. And it got there by competing on pricing.

That’s what makes Amazon’s problem big. It has been accustomed to competing on razor-thin margins, focusing on sales growth rather than profitability. Wal-Mart’s foray into Amazon’s markets may change the rules of the game— it will become extremely difficult for Amazon to raise the price of its “bundle,” or worse, it could fuel a price war that may extinguish Amazon’s thin profit margins.

Amazon.com versus Wal-Mart Stores

Company	Amazon.com	Wal-Mart Stores
Forward PE	154.98	13.42
Profit Margin	0.22%	3.32%
Operating Margin	0.72%	5.58%
Return on Assets (ttm)	1.14%	8.22%
Operating Cash	5.33B	24.30B
Revenue (ttm)	81.76B	477.18B

Source: finance.yahoo.com

Either prospect isn’t good for Wall Street, which has been on edge since Amazon’s last earnings report, sending its shares south.

BOTTOM LINE: Amazon’s winner take all strategy is pitting the company against other major players in every market in which it competes, causing price wars that erode its profit margins