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Yglesias on Amazon's P/E Ratio

Yglesias wonders why Amazon’s P/E is so high:

This raises the question in my mind, and not for the first time, of why Amazon merits aprice/earnings ratio of 310. For comparison’s sake, Wal-Mart is at 16, Apple is at 15,Target is at 15, Microsoft is at 15, and Home Depot is at 22. If you just compare Amazon’s P/E ratio to the other established retailers you might think “well it has a high valuation because it’s really a high-tech company.” But Amazon also has a much higher P/E ratio than established tech companies. The presumption seems to be that at some future point Amazon will be able to abandon its current model of huge volumes on tiny profit margins and thus supercharge earnings by raising margins. But for that to be the case, you have to assume that no other company will be able to compete with them in the web-based retail space even if they start charging higher prices.

Last quarter, Amazon’s profits dropped from $191 million to $7 million which resulted in their P/E ratio rising to astronomical levels. This changed didn’t happen because of lost sales (revenue went up 29%) or because Amazon suddenly became very inefficient; it happened because Amazon aggressively expanded the scale of its current operations and invested in new areas. $65 million of potential profits were spent on acquiring Kiva System and and construction started on 17 new warehouses this year while Amazon also worked at developing a phone and created entirely new business ecosystems.

Investors aren’t buying Amazon’s stock and hoping that Amazon will be able to raise prices and reduce costs without a competitor stepping in, like Yglesias suggests. They are investing Amazon’s ability to predict and profit from future technological disruptions:

ADAM LASHINSKY:Amazon is the only one, in my mind, of the big tech companies that’s actually reinvesting all its money, that has enough of a vision of the future that they’re actually able to reinvest all their profits.

PETER THIEL:Search technology was developed a decade ago. It’s a bet that there will be no one else who will come up with a better search technology. So, you invest in Google, because you’re betting against technological innovation in search. And it’s like a bank that generates enormous cash flows every year, but you can’t issue a dividend, because the day you take that $30 billion and send it back to people you’re admitting that you’re no longer a technology company.

I’m not a big Thiel fan, but the correctness of his point here is underscored by recent revelations that both Google and Apple spent more on patents – trying to preserve the status quo – then they did on R&D (nyt/original source). Amazon also sues over patents but they don’t spend billions of dollars on them and invests its money instead of hoarding.

While the P/E ratio is a useful metric, looking at it in isolation like Yglesias does ignores everything else about a company. While a P/E of 310 initially sounds ridiculous, it would be even more ridiculous to value Amazon so its P/E was 20 – its market cap would be several times smaller than the its available cash.