The Study of Amazon Inc.

The study looks at Amazon Inc. which is a global e-commerce firm. It contains an explanation of the rationale for choosing this company as well as the firm’s profile. Additionally, it includes the company’s financial analysis which makes use of the firm’s cash flow statements, balance sheets, income statements, and statements of shareholders’ equity. It also looks at the company’s portfolio analysis, shareholders’ wealth maximization strategies, and finally its capital structure.

Selection of the Company

Amazon is a multi-national company that deals with artificial intelligence, cloud computing, and e-commerce (Amazon.com, 2018). It was founded in 1994 by Jeff Bezos where it began operations as a bookstore. Later on, the firm diversified its activities and began to provide jewelry, food products, toys, furniture, electronics, apparel, software, video games, audio books, and MP3 as well as video streaming services (Amazon.com, 2018). It also owns a publishing firm and a television and film studio. The firm is headquartered in Seattle, Washington and has been named as one of the top firms globally in the technology space (Amazon.com, 2018). Based on its market capitalization and revenue, the company is the largest e-commerce firm across the globe. Currently, the company’s market capitalization is $686;019 billion since its share price as of 27th Dec 2018 was $1422.58 and its total outstanding common shares are about 482 million (Yahoo Finance, 2018).

Amazon was able to surpass Walmart and become the most valuable business in the retailing field in the United States based on its market capitalization in 2015 (Yahoo Finance, 2018). Statistics show that the company now brings in the highest amount of revenue when compared to all other forms across the globe (Morningstar, 2018). In the 2018 financial year, the firm earned a revenue of US$ 178 Billion which is an increase from the income collected in 2017 which was US$ 135.99 Billion (Morningstar, 2018). In the United States, the firm has been ranked to be behind only Microsoft and Apple based on its value and it also the second-largest employer (Sec.gov, 2018).   

The firm has also carried out various acquisitions over the years with the goal of increasing its market share and also diversifying its operations. Incidentally, the company acquired Whole Foods Market in 2017 for about thirteen billion and this led to an increase in the company’s presence in physical locations (Amazon.com, 2018). The entrance of the company in the brick and motor retail market was a move by the company to compete directly with Walmart which mainly operates in these stores since Walmart is its biggest competitor in the retail space.  

Amazon operates in various countries such as Brazil, Turkey, Singapore, Canada, Mexico, the Netherlands, Italy, India, Japan, Australia, Spain, Germany, and France (Amazon.com, 2018). The firm has also put measures in place to improve the quality of services it provides to the people in various countries by taking their language and cultures into consideration when providing them with services. Incidentally, it launched websites in the Turkish, Polish, Dutch, and German languages in 2016 (Amazon.com, 2018). The firm also offers international shipping to its customers in different countries.

The company has carried out various innovations over the years which have enabled it to provide effective and efficient services to its customers and remain highly competitive over the years. Earlier this year on 22nd January, Amazon launched Amazon Go (Amazon.com, 2018). This is a store that the company uses which makes use of sensors and cameras in the detection of items that shoppers take from the shelves. The technology then aids in the automatic charging of these items on the Amazon accounts of the different shoppers (Amazon.com, 2018). The store was first opened in Seattle (Amazon.com, 2018). This technology is innovative and also disruptive since it is new and also enables people to purchase items without having to follow checkout lines. By 2022, the company plans to have at least three thousand Amazon Go stores in the United States and even open more such stores in other nations across the globe (Amazon.com, 2018).

Rationale for Choosing Amazon Inc.

Amazon Inc. was chosen for this study over Walmart, IBM, and Tata Motors. The criteria adopted to pick this company involved a look at its growth process and brand equity, technological advancements, and its market capitalization. The firm was selected above the other companies because it has high brand equity. The firm began as a small company operated by Jeff Bezos, and it kept on expanding its brand equity by raising capital from different shareholders and establishing itself as the trusted provider of all e-commerce services (Amazon.com, 2018). The firm has also used disruptive innovation strategies in a bid to deliver high-quality services to its customers. In this age of technology, it is vital for companies to not only come up with new technological advancements but also create technologies which will disrupt operations and significantly impact the industry to differentiate themselves effectively from their competitors. Finally, the company has a very high market capitalization when compared to the other firms which has been increasing every year (Amazon.com, 2018). Therefore, as a future entrepreneur, studying the financial and non-financial elements of the company will provide a significant improvement in my view of business operations and enhance my knowledge on how to run a successful business and increase a company’s value over the years.  

Financial Statements

The financial analysis of Amazon Inc. looks at the company’s income statements, analysis of the firm’s report of shareholders, balance sheets, and cash flow statements over the past three years.

Income Statement and Balance Sheet Analysis

The analysis of the company’s income statements and balance sheets looks at the changes in the firm’s revenue, net profit, and operating expenses throughout three years from 2015 to 2017.  Additionally, it considers the firm’s profitability, liquidity, and investment ratios.

The company’s revenue has been increasing every year from 2016 to 2017 as depicted in table 1 and figure 1 below.  

year

revenue (billion)

2015

 $      107.01

2016

 $      135.99

2017

 $      177.87

Table 1. Source: (Sec.gov, 2018)

Figure 1

The firm’s net profit has also been increasing every year from 2015 to 2017 as depicted in figure 2 and table 3 below.  

year

net income (billions)

2015

0.6

2016

2.37

2017

3.03

Table 2. Source: (Sec.gov, 2018)

Figure 2

Amazon Inc.’s operating expenses have been fluctuating over the three years. Figure 3 and Table 3 below show the operating margin of the company between 2015 and 2017. The fluctuation of the firm can be attributed to the different expenditure on technological advancements and other spending activities aimed at increasing the company’s value in the medium and long-term.   

year

operating margin

2015

2.09

2016

3.08

2017

2.31

Table 3. Source: (Sec.gov, 2018)

Figure 3

Profitability Ratios

These are financial metrics that investors and analysts use in the evaluation and measurement of how well a firm can make a profit relative to the revenue that it generates and the costs that it incurs (Lesáková, 2017). The profitability ratios of Amazon Inc. are depicted in table 4 below.  

profitability ratios

2015

2016

2017

gross profit margin

20.51

22.41

22.87

net profit margin

0.56

1.74

1.71

operating margin

2.09

3.08

2.31

EBITDA margin

7.76

9.19

9.07

Table 4. Source: (Sec.gov, 2018)

The table shows that Amazon Inc. has had a very high gross profit margin over the 3 years. The gross margins have been increasing within this period which is a good sign since it means that the firm has been incurring reduced production costs within the entire period. The high gross margin is mainly because the company is more of a services company and is hence not involved in a lot of production. The net profit margin has been fluctuating within the period and is also very low. This means that the company has been incurring high expenses which have caused the gross profit initially realized to keep on reducing. This is not a good sign, and it is vital for the firm to increase its net profit levels by minimizing the expenses incurred. The operating margin has also been fluctuating in the same manner as the net profit. It is also not very high which means that the firm may be incurring high taxes which cause the gains to diminish significantly. Finally, the margin of the earnings before income, tax, and depreciation is quite high and has also been fluctuating within the three years. These statistics show that Amazon Inc. has been earning high gross profits relative to the revenue but very low net profits which call for a reduction in the costs of expenditure. It is, however, crucial to note that the company is still developing and is thus enhancing its operations and the high costs could be due to research and development practices aimed at the long-term advancement of the company.

Liquidity Ratios

The determination of a company’s liquidity ratios is crucial since liquidity ratios enable one to determine if a company can pay off its current debt obligations without having to raise capital from external sources such as using equity or by borrowing or selling bonds. Amazon Inc.’s liquidity ratios are depicted in table 5 below.  

liquidity ratios

2015

2016

2017

acid-test ratio

0.774

0.783

0.763

current ratio

1.076

1.044

1.04

Table 5. Source: (Sec.gov, 2018)

The table shows that Amazon Inc.’s acid-test ratio has been fluctuating over the period. The acid test ratio is at an average of 0.773 during the three years. The acid-test ratio is vital since it determines whether a company can pay for its debts only using its liquid assets. It hence determines the firm’s liquidity level. Durrah et a. (2016) states that liquidity refers to the ability of a firm to take care of any of its financial obligations as soon as they are due. A good acid-test ratio should be at about 1 (Durrah et al., 2016). Amazon Inc.’s acid-ratio is hence quite low, and it could mean that the firm may be unable to meet its short-term financial obligations if the management fails to address it properly. The firm, however, has an excellent current ratio which has been decreasing slightly year after year. Amazon Inc. hence needs to maintain its current ratio and increase its acid-test ratio to enhance its operations.

Investment Ratios

These ratios are critical for investors since they enable one to determine whether the firm is overvalued or undervalued without having to use complex valuation models (Arkan, 2016). The ratios are depicted in table 6 below.   

investment ratios

2015

2016

2017

price/book ratio

25.61

20.21

22.96

price/cash flow ratio

32.56

24.76

35.32

price/earnings ratio

951.96

171.6

297.58

Table 6. Source: (Sec.gov, 2018)

The ratios show that the price of the Amazon Inc.’s shares is valued higher than the firm’s book value, cash flows, and earnings. Therefore, these statistics show that people are optimistic about the company’s performance and they further show that the company’s stock is viewed as growth stocks. The different ratios have all been fluctuating over the years, but they show that the demand for Amazon’s shares has been high during the entire period.  

The balance sheet analysis of the firm also shows that the firm has a higher proportion of equity as compared to debt as shown in figure 4 below.

Figure 4. Source; (Morning Star, 2018)

Cash-flow statements and Statement of Shareholders’ Equity Analysis

Table 7 below shows that Amazon Inc.’s free cash flows have been fluctuating within the period. The cash flows are however positive which means that the company has had extra cash after every financial year. Therefore, the company’s cash from operating activities has been higher than the money deducted for investment and that used for financing activities.

free cash flows

2015

2016

2017

amount

7331

9706

6479

Table 7: Source (Sec.gov, 2018)

Analysis of the statements of equity show that institutions own the majority of the firm's stocks, then mutual funds, and the lowest percentage is held by insiders as depicted in figure 5 below.

Figure 5. Source: (Morning Star, 2018)

The analysis of the company’s financial statements, therefore, shows that the firm should reduce its debts relative to its equity and increase its acid-test ratio to increase its liquidity. Additionally, it shows that the company should minimize its operating expenses in a bid to boost its net income margin and maintain its cash flows by ensuring that there are no negative free cash flows in any given year.

Time Value of Money

The time value of money has its basis on the idea that a given amount of money has a greater worth in the present than it will be worth in the future (Chen, 2009). The difference in the value of money is due to its earning potential. The money can, therefore, be invested in a venture where it will earn simple or compound interest for the investor. The concept of the time value of money is crucial for investors since it shows them that a dollar in hand has a higher worth than one promised in the future since the dollar the investor has can be invested and earn capital gains or interest. Analysis of Amazon Inc.’s investment activities shows that the company invests in both products and services, but its most significant growth has been in the services sector. Statistics show that the company has grown both in capital gains and in revenue generated by the different products and services. Inflation has also occurred within the period of the company’s operations, and the investment of funds has enabled the company to deal with the devaluation of currency which has been brought about by inflation. Figure 6 below shows the rates of inflation from 1910 to 2010. The trend has been continuing which means that companies have to invest their money to avoid losing their value.  

Figure 6. Source; (Statista, 2018)

To determine how much a certain amount of money which will be received in the future is worth, one needs to calculate the present value of that amount by applying the appropriate discount rate. Amazon Inc. uses this principle when making investments to avoid making losses and to increase its value.  

The opportunity cost of capital refers to the benefits lost when one chooses a particular source of funds over the second-best alternative (Damodaran, 2016). Amazon Inc. uses capital both from shareholders and creditors. The firm seeks the cheapest source of funds which will deliver the highest value which is why it uses more of shareholders’ capital when compared to loans. The company also considers the risks that it will bear with its chosen source of capital. Raising capital through the sale of equity means that the firm will bear lower risks than when using borrowed funds (Damodaran, 2016).

Additionally, the company prefers to use more equity than debt since equity has much lower costs of capital incurred when compared to loans which require the firm to pay interest after a certain pre-agreed period until the debt is fully paid. Finally, the preference of equity to debts is that creditors have a senior claim over the firm’s assets in cases of defaults when compared to the preferred and common shareholders which means that the firm may lose its assets in case it fails to repay its debts on time. However, shareholders have a much lower claim on the company’s assets, and they do not have to receive dividends every year especially during the growth stage. Amazon Inc. has failed to pay dividends to its shareholders for many years in a bid to re-invest its earnings into the business (Amazon.com, 2018).

There are various investment rules that Amazon Inc. follows which have made it very successful over the years. The company invests in different areas with the goal of maximizing its total real returns. It usually does not invest in fixed income investments since it is aware that it needs to counter the effects of inflation and taxes (Amazon.com, 2018). The firm’s investments usually yield high-profit levels since the company has applied technology in its operations (Amazon.com, 2018). Additionally, the company has used strategies that enable it to pay low taxes. Incidentally, the company paid a tax fee of (-$83 million) in 2014 (Sec.gov, 2018). The firm is also highly flexible about different types of investment, and it also has a highly diversified portfolio (Sec.gov, 2018). It deals with e-commerce where it provides all kinds of products from food, books, electronics, jewelry, among others.

Additionally, it has a television studio, a publishing arm, and cloud infrastructure, among others (Amazon.com, 2018). The company also does not follow trends but instead creates them. This is depicted in its technological advancements which are new and disruptive and its business model.

Capital Budgeting

Capital budgeting refers to the process by which firms determine whether they should invest in particular large projects (Ho, 2018). Companies then invest only in the projects that are expected to increase their value (Rossi, 2014). Capital budgeting techniques include determination of the payback period, accounting rate of return, and the net present value technique among others (Kengatharan, 2016).

Amazon Inc. has used the strategy of capital budgeting analysis over the years to determine investments that will increase their revenue. For instance, it has invested in artificial intelligence and machine learning since it is expected to deliver high value in the future by increasing revenues while minimizing the costs that will be incurred by reducing labor expenses and saving on costs (Amazon.com, 2018). The firm also uses online marketing significantly which delivers high value while minimizing the costs it incurs.

Finally, the firm has adhered to government regulations such as employing locals in their areas of operation by adapting their products and services to the cultures where they operate in a bid to capture the local market since this will enable the firm to break-even in the regions much faster (Amazon.com, 2018).

Portfolio Analysis

A portfolio refers to a combination of securities. According to Bernard, Denuit & Vanduffel (2016), portfolio analysis is the process in which quantitative data is used in the selection of the optimal portfolio that an entity can hold which will bring a balance between return maximization and risk minimization. The choice of an optimal portfolio requires one to determine the desired return and the level of risk that one can bear. Businesses usually invest in environments that are characterized by uncertainty, and some choose to diversify their investments to minimize their risk levels while maximizing their returns. According to Elton & Gruber (2017), diversification is a step that entities take in a bid to reduce risks by allocating different investments among diverse industries or financial instruments.

Amazon Inc. has widened its portfolio by increasing the number of areas where it operates in. Therefore, due to this diversification, the company is not profoundly affected by volatilities that may occur in particular industries since only a small portion of its business operations are focused on that area. The company expects the technology sector to bring in the highest revenues which is why it has huge investments in this sector (Amazon.com, 2018). It, therefore, has a diversified portfolio which contains significant investments in areas that are expected to generate the highest returns, with the lowest volatility, and risk levels.

Shareholders’ Wealth Maximization

Figure 7 below shows the movement of Amazon Inc.’s share price from 2005 to 2018 (Yahoo Finance, 2018). The firm’s share price has been increasing every year within that period. Therefore, the shareholders have enjoyed massive capital gains over the period. The company has not been paying dividends to its shareholders, but its performance based on its revenue, net profits, the increase in its market share, and its employment of disruptive technological advancements show the investors that their investments are still generating great value even without dividends.

Figure 7. Source: (Yahoo Finance, 2018)

Capital Structure

Amazon Inc. has also been paying very low taxes by taking advantage of the tax cuts provided by the government (Yahoo Finance, 2018). The firm also provides its employees with a career program in which it pays about $12,000 of their education expenses which increases their motivation and skills levels consequently increasing business productivity (Yahoo Finance, 2018).

Amazon Inc.’s capital structure is made up of both equity and debts. As depicted in figure 4, the company currently has a higher deficit than equity (Yahoo Finance, 2018). As of 2017, the firm’s debt to equity ratios are as shown in table 8 below (Yahoo Finance, 2018).

Table 8. Source: (Sec.gov, 2018)

As shown in the table above, Amazon Inc.’s capital structure has been fluctuating over the year with a higher debt to equity in some cases and higher equity to debt in others. Even though the firm currently has a higher ratio of equity to debt, its capital structure is still highly volatile. The firm is also highly leveraged with an equity to debt ratio of 1.585.

Nevertheless, Amazon Inc. has been able to utilize the borrowings that it has to generate high cash flows and returns due to its high revenues and net profit depicted in tables 1 and 2. That is why the company’s value has kept on increasing and over the past three years’ statistical analysis show that its share price has been able to appreciate by one than one hundred and fifty percent. A breakdown of its debt and capital capitalization as at 2nd February 2018 which was the last financial year is explained below.

Debt Capitalization

Amazon Inc.’s debt is grouped into two categories. These are the current and long-term liabilities. The firm at the end of the 2017 financial year had current liabilities worth $57,883 million. Its long-term liabilities, on the other hand, were worth $45,718 million (Sec.gov, 2018). The firm’s total liabilities were thus equal to $103,601 million (Sec.gov, 2018).

Equity Capitalization

The value of the shares held by the common shareholders was $387.327 billion with 484,107,183 outstanding shares (Sec.gov, 2018). The firm has preferred shares which have a par value of $0.01. Additionally, there was treasury stock with a cost of $1,837 million. Moreover, there was an additional paid-up capital which was equal to $17,186 million and an accumulated loss of $985 million (Sec.gov, 2018).

Therefore, at this period, the company had a much higher equity holding when compared to its liabilities which means that the risks incurred were low.

Summary

In conclusion, this study has shown that Amazon Inc. is very successful in its operations due to its high market capitalization, market share, and brand equity. However, its financial analysis shows that it is highly illiquid and leveraged and may be unable to meet some of its short-term and long-term financial needs if the management does not apply proper financing techniques.

References

Amazon.com. (2018). Amazon.com: Online Shopping for Electronics, Apparel, Computers, Books, DVDs & more. Retrieved from https://www.amazon.com/

Arkan, T. (2016). The Importance of Financial Ratios in Predicting Stock Price Trends: A Case Study in Emerging Markets. The University of Szczecin, Department of Economics, 1(2016), 4-20.

Bernard, C., Denuit, M., & Vanduffel, S. (2016). Measuring portfolio risk under partial dependence information. Journal of Risk and Insurance, 85(3), 843-863. doi: 10.1111/jori.12165

Chen, J. (2009). Time Value of Money and Its Applications in Corporate Finance: A Technical Note On Linking Relationships Between Formulas. American Journal of Business Education, 2(6). Retrieved from https://files.eric.ed.gov/fulltext/EJ1052630.pdf

Damodaran, A. (2016). The Cost of Capital: The Swiss Army Knife of Finance. New York University, 1(2016), 3-10.

Durrah, O., Rahman, A., Jamil, S., & Ghafeer, N. (2016). Exploring the Relationship between Liquidity Ratios and Indicators of Financial Performance: An Analytical Study on Food Industrial Companies Listed in Amman Bursa. International Journal of Economics and Financial Issues, 6(2), 435-441.

Elton, E., & Gruber, M. (2017). Portfolio Analysis with Partial Information: The Case of Grouped Data. Management Science, 33(10), 1238-1246. doi: 10.1287/mnsc.33.10.1238

Ho, A. (2018). From Performance Budgeting to Performance Budget Management: Theory and Practice. Public Administration Review, 78(5), 748-758. doi: 10.1111/puar.12915

Kengatharan, L. (2016). Capital Budgeting Theory and Practice: A Review and Agenda for Future Research. Applied Economics and Finance, 3(2). doi: 10.11114/aef.v3i2.1261

Lesáková, Ľ. (2017). Uses and Limitations of Profitability Ratio Analysis in Managerial Practice. Faculty of Economics, Matej Bel University, 1(2017). Retrieved from https://kgk.uni-obuda.hu/sites/default/files/24_Lesakova.pdf

Morningstar. (2018). AMZN Amazon.com Inc. Stock Quote Price. Retrieved from https://www.morningstar.com/stocks/xnas/amzn/quote.html

Rossi, M. (2014). Capital budgeting in Europe: confronting theory with practice. International Journal of Managerial and Financial Accounting, 6(4), 341. doi: 10.1504/ijmfa.2014.066403

Sec.gov. (2018). Amazon Inc. 10-K form. Retrieved from https://www.sec.gov/Archives/edgar/data/1018724/000101872418000005/amzn-20171231x10k.htm

Statista. (2018). Amazon: annual revenue 2017. Retrieved from https://www.statista.com/statistics/266282/annual-net-revenue-of-amazoncom/

Yahoo Finance. (2018). Amazon.com, Inc. (AMZN). Retrieved from https://finance.yahoo.com/chart/AMZN