Is Amazon a Buy After Poor Q3 Earnings?

Who doesn't love Amazon AMZN? Their easy to use website has helped myself and millions of other Americans buy items at discounted rates. They have also released e-reader devices and tablets. However, Amazon recently reported poor third quarter earnings. In fact, Amazon reported an EPS of $0.14 versus an estimate of $0.24 on revenues of $10.9 billion versus an estimate of $10.93 billion. Does this earnings release mean that Amazon's operations are starting to falter?

Unlike many other companies in the technology industry, Amazon did not pursue risky maneuvers in the last quarter. Certain companies, like Netflix NFLX, tried altering a brand name in a way that ultimately hurt them. In the case of Netflix, senior management tried to divide the DVD mail-in service from the online streaming service. Many subscribers were not appreciative of that. Amazon also has various services that are available to all of its customers. If it had tried to separate general goods markets from e-book markets, subscribers may not have liked that.

Amazon also did not change its pay structure like Netflix. Amazon charges people who sell their goods through its website a commission per sale. Amazon also reimburses all of the sellers for shipping costs. If Amazon had increased commissions, stopped reimbursements, or even charged customers for using the selling service, Amazon would have lost a significant amount of revenue. By preserving a tried and true pay structure, Amazon managed to preserve much of its business compared to companies like Netflix.

One of Amazon's unique services is called Amazon Prime. It offers subscribers discounts on certain items and free two-day shipping on many other items. According to Amazon executives, the company lost a lot of money due to Amazon Prime's shipping opportunities. Although Amazon charges $35 for year-long subscriptions, expedited shipping often costs $20 or $30 depending on the item. Although Amazon “reimburses” sellers, reimbursements are frequently only $10 to $15. Over time, the spread that Amazon profits from is extremely high. With free shipping, Amazon does not profit from the spread but also continues to pay sellers their reimbursement. It is easy to see just how much money Amazon could have lost during the trailing three months.

The biggest question is if Amazon is a buy or sell. Amazon looks very attractive at these price levels, but are sales slowing down? Amazon may be suffering from the same problem that Apple AAPL is facing. Apple's iPhone and iPad products are starting to see slowing growth, and subsequently, reported poor third quarter earnings as well. While Amazon's Kindle Fire just debuted, its biggest physical product, the Kindle E-Reader, may have slowing demand as well. While the sales garnered from the Kindle Fire may defray the losses from the original Kindle, the next few quarters may see slower growth for both products.

One other aspect that investors need to realize is that the fourth quarter typically results in high revenues for retailers, including websites like Amazon and eBay EBAY. For example, in 2010, Q3 revenues were $7.5 billion and Q4 revenues were $12.9 billion. Via simple extrapolation, Q4 revenues in 2011 may hit $14.5 billion. Regardless of exact numbers, the next few months are squarely in the middle of “shopping season.” The day after Thanksgiving, colloquially called Black Friday, is extremely popular for retailers to sell many items at discounted prices to free up inventories. However, the real bread-winner is the shopping frenzy for Christmas. Amazon is bound to see increased sales during the fourth quarter, in this regard.

Lastly, investors need to remember that macroeconomic factors almost always trump individual companies' performance. In the event the debt problems in the US and Europe are not solved, one of the first things to be affected is the general public. Unemployment may skyrocket, general morale may severely decline, and extravagance may be shut down. Extravagance, in this doomsday scenario, is very loosely used. Extravagance includes spending money on food or other consumer retail items. Stores including Amazon, Macy's M, and Nordstrom JWN will be invariably affected.

As a company that operates in the consumer retail and technology industries, Amazon's operations may be diversified enough to recover losses incurred in the third quarter. Only time will tell, but Amazon may also be losing steam in its website's business model, as consumers have access to hundreds of other similar websites and retailers. Investors need to understand two primary things. They need to determine where the overall economy is going, at least in the next few months, and they need to determine how Amazon is going to operate.

Amazon is currently trading at about $203, up nearly 13% for 2011.