Earnings Preview: What You Need to Watch

Source: is scheduled to report earnings on Thursday, Oct. 23, after the market closes. The online retail juggernaut is having a difficult year. Amazon stock is down by nearly 24% year to date as investors are getting disappointed with the company's financial performance in recent quarters. Will the coming earnings report from Amazon mark a turning point for the stock, or should investors brace themselves for more bad news?

Growing sales
Amazon is expecting sales for the third quarter to be in the range of $19.7 billion to $21.5 billion, representing an annual increase of between 15% and 26% versus the third quarter in 2013. This is a fairly wide range, and Wall Street analysts estimate that actual sales will be near the high end. Analysts polled by Thomson Reuters are on average forecasting revenue of $20.84 billion for the quarter.  

If the numbers are in line with analysts' forecasts, that would represent a 22% increase over $17.1 billion in the third quarter of 2013 -- quite an exceptional growth rate for a company of Amazon's size.

When analyzing sales figures for Amazon, it's important to keep in mind that third-party sales account for a big 40% of unit sales, and Amazon only recognizes the value of the services it provides to third-party sellers in these transactions. When someone buys a product from a third-party seller via Amazon, the company accounts for services such as shipping and payment processing, not the value of the product.

That means accounting sales may not tell the whole story when it comes to evaluating Amazon's growth and competitive position, so investors may want to keep that in mind when looking at the numbers.

Falling earnings
Management is forecasting an operating loss of between $410 million and $810 million for the third quarter, a considerable deterioration versus an operating loss of $25 million in the same quarter last year. As Amazon steps up its investments in areas such as distribution and its Amazon Web Services division, profit margins have been under heavy pressure over the past several quarters.

Wall Street analysts are on average forecasting a net loss of $0.74 per share for the third quarter. Earnings estimates have been consistently declining through the past year, so the bar is getting lower and lower for Amazon when it comes to earnings expectations.

AMZN EPS Estimates for Current Quarter Chart

AMZN EPS Estimates for Current Quarter data by YCharts

Amazon has reported widening losses in the past several quarters, and guidance has also been quite negative in terms of profit margins, so Wall Street analysts are cutting their earnings forecasts to reflect this lack of profitability.

It's good to know that analysts have already adjusted their expectations downward to a considerable degree. However, the trend is clearly quite negative for Amazon when it comes to profitability, so it's really hard to tell whether things are stabilizing or losses will continue getting larger in the coming quarters.

Focus on the cash flows
Amazon doesn't care much about profit margins. The company is all about maximizing cash flows over the long term. This is a smart approach, since the value of a business ultimately depends on the cash it produces, not on profit margins. In the words of Amazon founder and CEO Jeff Bezos:

Percentage margins are not one of the things we are seeking to optimize. It's the absolute dollar free cash flow per share that you want to maximize, and if you can do that by lowering margins, we would do that. So if you could take the free cash flow, that's something that investors can spend. Investors can't spend percentage margins. 

Cash flows from operations during the 12-month period ended on June 30 increased by a healthy 18% to $5.33 billion, so the business is generating big and growing sums of cash from its regular operations. Capital expenditures required $4.29 billion during the period, mostly because of investments in areas such as fulfillment operations and technology infrastructure.

Huge investments in different areas are absorbing a big part of Amazon's operating cash flows and weighing on the company's free cash flows. However, these investments are also consolidating Amazon's competitive position and setting the stage for long-term growth for the years ahead.

While Wall Street analysts and most media outlets tend to focus their attention on variables such as sales and earnings, operating cash flows can be just as important, perhaps even more so, when evaluating Amazon's coming earnings release.

The bottom line
Wall Street is expecting healthy sales growth from Amazon, while profit margins are forecasted to remain under heavy pressure. Sales and earnings usually grab most of the headlines, though, so investors may want to keep their eyes focused on Amazon's cash flows.

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The article Earnings Preview: What You Need to Watch originally appeared on

Andrés Cardenal owns shares of The Motley Fool recommends and owns shares of Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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