Amazon.com (NASDAQ: AMZN) The second quarter results clearly disappointed the market when released last week. The stock opened 7 percent lower on Friday and remains nearly 12 percent below the all-time high it hit two weeks ago. While quarterly EPS topped estimates, reported revenue was $ 2 billion lower than forecast. However, it was the advice that really scared the market. Amazon warned that revenue growth is expected to fall to between 10 and 16 percent in the third quarter, with slower growth likely to continue for several quarters.
Longtime Amazon investors know that the company often targets lower EPS during times of high investment. Income growth has also been quite cyclical in the past. Another aspect of Amazon’s business that is becoming increasingly evident is its complexity.
Amazon is now more than just an online retailer. The different business segments all grow at different rates and have very different margins. The following table illustrates how different the three main lines of business are.
|% of net sales||Annual growth||Operating margin|
Amazon net sales by business segment, Q2 2021 ( Source: SEC filing )
The following table breaks down Amazon’s net sales for the second quarter by product and service type. We can see that the year-over-year growth rates for the quarter ranged from 11% for physical stores to 87% for advertising.
|% of net sales||Annual growth|
|Third-party vendor services||22%||38%|
|Other (Mainly advertising)||7%||87%|
Amazon net sales by product and service, Q2 2021 ( Source: SEC filing )
The complexity of all of these business segments can make it quite difficult to assess how Amazon actually performs. Additionally, Amazon reinvests so much of its cash flow that sometimes it doesn’t seem as profitable as it actually is.
One way to get a better idea of ââthe profitability and efficiency of the business is to look at Amazon’s return on equity. Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. Simply put, it is used to assess a company’s profitability against its equity. It can also help us determine how well a business is allocating capital over time.
Check out our latest review for Amazon.com
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, the ROE for Amazon.com is:
26% = US $ 29 billion Ã· US $ 115 billion (based on the last twelve months to June 2021).
The “return” is the annual profit. This means that for every dollar in shareholders’ equity, the company generated $ 0.26 in profit.
What is the relationship between ROE and profit growth?
So far we’ve learned that ROE is a measure of a company’s profitability. We now need to assess how much profit the business is reinvesting or “holding back” for future growth, which then gives us an idea of ââthe growth potential of the business. Assuming everything else is equal, companies that have both a higher return on equity and higher profit retention are generally those that have a higher growth rate than companies that do not have the same characteristics.
Amazon.com profit growth and 26% ROE
First, we recognize that Amazon.com has a significantly high ROE. Second, even compared to the industry average of 19%, the company’s ROE is quite impressive. As a result, Amazon.com’s exceptional 48% net profit growth seen over the past five years is no surprise.
We then compared the net income growth of Amazon.com with the industry and we are delighted to see that the company’s growth figure is higher than that of the industry which has a growth rate of 29. % during the same period.
Profit growth is a huge factor in the valuation of stocks. What investors next need to determine is whether the expected earnings growth, or lack thereof, is already built into the share price. This then helps them determine whether the stock is set for a bright or dark future. Is the AMZN correctly valued? This intrinsic business value infographic has everything you need to know.
Amazon.com Reinvests Retained Earnings Very Effectively
Amazon is well known for reinvesting its profits into growth, both by building new retail infrastructure and by reinvesting in new businesses. This means that income does not always increase steadily. However, Amazon manages to invest in companies like Amazon Web Services and the advertising industry. This resulted in an improvement in ROE from just 4% in 2015 to 26% in the last 12 months.
The company warned that revenue growth is expected to slow over the next few quarters. The good news is that the company’s ROE is improving, which may offset some of the slower revenue growth.
To learn more about the company’s future earnings growth forecast, take a look at this free analyst forecast report for the company to learn more.
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Simply Wall St analyst Richard Bowman and Simply Wall St have no positions in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents.
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