Amazon Isn't Necessarily a Bubble

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It's easy to look at a stock that trades at a rich multiple and dismiss it as a bubble. While Amazon may or may not be a bubble in the traditional sense, it is important to understand that Amazon's lack of earnings doesn't necessarily mean that the stock is overvalued.

Amazon's research and development has gone wild
One of the biggest drains to traditional profitability has been the company's intense research and development. This covers everything from the traditional costs to develop and maintain the site and the various services, such as Amazon Cloud Player, to some of the more out-there projects, such as its work on package-delivering drones. To understand how much this has been eating at traditional profitability, note that Amazon's R&D spending has increased from less than $1 billion in 2008 to a hair more than $6 billion over the last 12 months.

The naysayers who point out that Amazon's profitability has been largely non-existent have a point: Amazon will eventually need to see a real financial return on those investments. However, nobody said that the return would come now, and the return may not manifest itself directly. Even if Amazon doesn't earn a dime on the sales of a Kindle Fire HDX, it could lure customers into the Amazon ecosystem, and that ultimately translates into more sales and a wider moat. That's the goal of this increased R&D spending, anyway.

Amazon's story is compelling
With enough revenue growth in place to divert investors' attention away from the anemic net-income/free-cash-flow situation, Amazon is pretty boldly attacking other growth areas. Amazon's Kindle Fire HDX goes neck-and-neck with Apple's finest iPad Air and iPad Mini tablets for much cheaper, since Amazon doesn't really need to make much of a profit on the actual devices. At the same time, Amazon is one of the leaders in cloud computing, much to the chagrin of IBM , which has been aggressively pursuing the cloud and claims to have 1,400 cloud patents and 37,000 cloud experts worldwide.

On top of all of that, there's the core online retailing business, which is widely viewed as the paragon of convenience. With the economy continuing to recover -- and with Amazon's incredibly customer-friendly policies -- it's not difficult to understand why Amazon's customers continue buying at a growing rate. To understand just how robust this growth is, sales are expected to be up 22.6% this year from $61 billion to $75 billion. Next year, that revenue number is expected to reach $91.53 billion. If Amazon can actually hit these targets and continue growing like this, the optimism seems justified.

Foolish bottom line
Amazon is richly valued, and buying after this kind of a run is probably risky. But there is rationality to what seems like irrationality here. Amazon is investing heavily in its business and is growing its top line well enough to support that investment. While it may all end up falling apart in the end, it seems that Wall Street is willing to give Jeff Bezos and his team the benefit of the doubt. Do Amazon's shares look like a compelling buy here? Not particularly, but many said the same thing at $100, $200, and even $300. 

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The article Amazon Isn't Necessarily a Bubble originally appeared on

Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends and Apple. The Motley Fool owns shares of, Apple, and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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