Big Amazon Earnings Shock: Press and Analysts Get It Wrong

Last Updated Oct 26, 2011 5:29 AM EDT

Reading the reports about the latest Amazon (AMZN) quarterly earnings announcement, you'd think that CEO Jeff Bezos had doused himself with a barrel of red ink and then rolled all over the books. The "company is sacrificing profit margins" as it looks to gain market share and sales volume, said Bloomberg. Investors punished the stock with a $25 price drop in after hours trading, as the New York Times reported.

Uh, doesn't anyone bother to read beyond the top few paragraphs in an earnings release and look at the actual financials? Or is it too much work to scroll down the page? Business Insider was right when it said that Amazon just had a great quarter. Not only is the company taking the right steps to deal with changes in the market, but many of the sadly shaking heads didn't even get the basic business math right.

Margins didn't drop
You might understand the inclination to assume that Amazon's margins had dropped. The company had continued to cut the price of its Kindle e-reader family. But the actual financials offer a sharply different picture if you bother to look at them. Here's a modified version of Amazon's statement of operations with the addition of expenses as a percentage of revenue (click to enlarge):

To say that Amazon is sacrificing profit margins to increase sales volume and market share is incredibly misleading. Look at cost of sales. Quarterly gross margins didn't drop at all, year over year. Cost of sales were up by 0.1 percentage point of revenue in the first nine months of 2011 compared to 2010. Contrary to much of the instant analysis, the issue in this quarter was not lowering prices. Amazon proved that it didn't have to.

It's called investment
No, the drop in profit came primarily from two areas: technology and content as well as fulfillment. The increases in these two areas in the year-over-year quarter comparison accounted for 2.6 percent of revenue in increased expenses. Add the slight increases in both marketing and general and administrative (overhead), and you get 2.8 percent of revenue, or the difference between this year and last.

Amazon has been building new warehouses at a rapid pace and has been pouring money into developing the new Kindle Fire, cloud offerings, and, presumably, other technology and products it will roll out over time. As Pascal-Emmanuel Gobry wrote in Business Insider:

Amazon is seeing huge demand, and responding to it. Big demand for its commerce business, which is about 0.5% of global retail, for its cloud business, which is rip-roaring (as you can see on the chart at right), and huge demand for its Kindle, which is the future of its media business, which is about 45% of revenue.
Time and again, Bezos has been willing to put money into the business to grow it over time, and he's largely pulled it off.

Next quarter
The other major complaint was that Amazon's guidance for next quarter wasn't what investors wanted to hear: the company would see big profit declines of between 47 percent ($250 million profit) and 142 percent ($250 million loss). Oh, dear, Amazon is trying to take on Apple (AAPL) with the Kindle Fire tablet and will lose money on each one.

So? Is Amazon supposed to ignore Apple? It can't afford to, and selling an inexpensive tablet to help lock consumers into its own ecosystem is a vital step in addressing a fundamental market change. Whether Amazon will succeed in the long run is up in the air, but the company is displaying intelligent and prudent management, investing when it must for the future, rather than playing the typical games to make Wall Street happy today at the cost of the business tomorrow.


Image: Flickr user etech.
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    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.