Financial Analysis of Amazon.com Inc.

This paper seeks to analyze the financial statements of . com Inc. for the years 2005, 2006 and 2007 by interpreting its profitability, liquidity, leverage and activity ratios and comparing the same with industry averages. This will also analyze the company’s growth rates, valuation ratios (price) and dividends and will employ horizontal and vertical analysis in process as needed. 2. Analysis and Discussion 2. 1 Profitability Return on equity of Amazon. com Inc. shows many things about the past performance of the company in the past five years.

The continued decrease from 2005 through 2007 appears noticeable but the rates are still very high. . From 145. 93% in 2005, it has hugely decreased to 44. 08% in 2006 and further to 39. 77% in 2007. Such level of profitability is still very for purposes of determining a company’s profitability. Compared to industry average of 24. 9%, the company’s ROE is still higher. See Exhibit I in the Appendix. The range of 39% to 145% return on equity encourages investors as it would mean that for every $100 investment, the investors expect returns of about $39 to $145. These rates could be viewed as something unprecedented for a company like Amazon.

com Inc.. Its level of ROE is something that must be the envy of many other companies such as EBay Inc. , Enable Holdings and Friendly Auto Dealers, Inc (Yahoo Finance, 2008). It may be noted that return on equity is solved under the formula where net profit is divided by the total stockholders equity. When compared to an average rate of 1. 5% US base rate (Housepricecrash, 2008 ) if money was invested in a bank, the company’s would seem to offer more than twenty fold and it is something very difficult to find and would therefore make it very attractive to investors.

The company’s return on assets for the years 2006 through 2008 ranges from 4% to 9% and which appears to be obviously lower that its ROE. The same may be observed in relation to the company’s net profit margin for last three years and has not even exceeded 5% in any period. However, ROE must be superior in declaring the profitability of Amazon as compared to all other profitability ratios. Operating margin which measures within the range of 3 to 5% for the three years, represents the margin after deducting cost of sales or services and operating expenses.

Things to be added or deducted still are other income(s). The ratios mean that the management of Amazon. com Inc. is doing well that it must thank its employee’s participation of employees in delivering value to customers. The net margins of the company for the three years are lower than operating profit margin, due to the additional deductions of interest expenses. The profitability ratios such as return to equity, operating profit margin and net profit margin have the capacity to show historical profitability but investors would base also their decision on estimates of the future.

Since conditions change, wise users of financial information may just give more values to estimated cash flow in the future for valuing their investments in terms of dividends to be received from the company. This appears to be found in the case of Amazon as proved by high debt equity as would be discussed later in relation to its profitability. 2. 2. 2 Liquidity Liquidity enables a company to meet its currently maturing obligations. It is measured using the current ratio and the quick asset ratio.

Current ratio calculation uses current assets to be divided to current liabilities while quick assets ratio is almost the same except that the inventory and prepaid expenses are being removed from the current assets to have a new numerator but the denominator is the same. Quick assets therefore normally include cash, marketable securities and accounts receivable and the use of quick asset ratio is very much relevant for one intending to have higher form of measuring liquidity. In such case, one would prefer quick asset ratio over that of the current ratio.

As applied now, the current ratios of Amazon. com Inc reflected 1. 39, 1. 33 and 1. 54 for the years 2007, 2006 and 2005 respectively while the quick asset ratios for same years are 1. 02, 0. 95 and 1. 19 for the same years respectively. See Exhibit I in the Appendix. Both ratios showed fluctuating trend where decreased was first noted and then increase followed after. The company’s liquidity may be considered to be still very high since current ratios average more than 1. 3 while quick asset ratio averages about more than 1.

0 for the last three years. It current ratio for 2007 is very close to industry average of 1. 8 while its quick ratio of 1. 02 is not very far from industry average of 1. 6. Both its liquidity ratios are better when compared with S&P 500 index. See Exhibit I in the Appendix. The good liquidity appears to be a result also of good profitability of the company as observed earlier in terms of very high return on equity. 2. 2. 3 Leverage ratios Financial leverage or solvency refers to the company’s capacity to keep it stability over the long term.

Generally measured by the debt to equity ratio, with the formula of having the total debt of the company divided by its total equity; a good financial leverage assures investors that the company is not to just to exist in the short term but it must also have a long life to recover long term investments which takes years to produce the needed returns. The debt to equity ratios of Amazon. com Inc. are 4. 42, 9. 12 and 14. 02 for the years 2007, 2006 and 2005 respectively. These ratios are however not as good as industry average of 0. 32. See Exhibit I in the Appendix .

The ratios are indeed very high since the ratio of more than 4. 0 means that the value the company investments is not matched by what it borrows by about more than 400%. Remarkable Improvement were however recorded from 2005 through 2007. This must be due to its very high profitability. This could mean that the company is expanding business as noted its net fixed assets reflecting growth rates of 25. 06%, 22. 53% and 67. 91%, the years 2007, 2006 and 2005 respectively. See Exhibit I in the Appendix. In other words, expansions are getting financed hugely from operations which is a sigh of a healthy company.

Good solvency is a proof of good capital structure and for Amazon. com Inc. the same could be attainable as shown in the very remarkable improvement if its debt to equity ratio which cut more than half that on 2006 in 2007. Given also its very good liquidity as analyzed earlier, the company must be declared to have clean bill of health in financial terms. 2. 2. 4 Efficiency ratios The company’s profitability is being supported by its good efficiency ratios. Inventory turnovers for three years are very much higher than industry average and such efficiency is indicative of its better performance than competitors.

Even its collection period and receivable turnover are definitely above industry and S&P 500 index. No wonder the massive improvement in leverage ratio for two years is more than justified. 3. Conclusion Amazon. com is growing very remarkably in term of revenues, fixed assets, and net income. The increase in net income of more than 60% in 2007 is not easy to disregard and the fixed assets growth averaging more than 20% for the last three years could only mean an expanding company under a very favorable condition in the industry.

Its profitability ratios, liquidity ratios, leverage ratios and activity ratios are very favorable to the company. Its profitability is sustaining not only its liquidity by keep improving is highly leverage financial condition. Although, 2007 liquidity and leverage ratios are not as good as industry averages, the chance that they could be improved soon by company’s profitability is very big given its higher than industry average ROE for the last three years. The activity ratios in terms of inventory turnover and receivable turnover in 2007 are higher than industry average which could only support for the company’s very high profitability.