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Michael Baxter's thoughts for this day

02/02/2012 - Amazon sees share price collapse, but it is still set to become one of the world's most valuable companies

When a company gains a valuation of almost 100 times estimated 2012 profits, warning bells ring. And this week the bells have been ringing very hard indeed. Shares in Amazon dropped 10 per cent on Tuesday. The growing consensus seems to be that, yes, it is a good company, but the valuation is absurd. I am not so sure, and still reckon Amazon will be rivalling Apple for profits, market presence and market cap later this decade.

Real estate is valuable. At the moment, the UK high street is struggling. Even so, if you are a landlord who owns retail space on a busy high street, your assets are worth a tidy sum. But, bit by bit, the Internet is taking over. Each year, online sales eat into traditional high street sales. Not so long ago, retailers were cynical. "The Internet will never take off as a shopping channel," or so a retailer friend used to say to me "because shopping is a social activity." During the aftermath of the dotcom crash it seemed he was right. But ever since, Internet sales have steadily risen. In some years they have seen meteoric growth, meanwhile the traditional high street has limped.

Many look at the likes of Google and Facebook, and ask: how can these companies possibly be worth so much when their sole source of income is advertising?

Well, for what it is worth, I think Facebook is overvalued, but critics miss the point. What we mean by advertising has changed. The industry we used to call advertising has been merging with the industry we used to call commercial property - at least partially. A good position on Google, or a popular app on an iPhone, can be just as valuable as a piece of prime real estate on a busy high street.

A popular web site doesn't merely take revenue from advertising budgets, it takes revenue from what used to be budgeted for retail space too. And that's the point that gets forgotten.

Facebook worries me for a host of reasons, including privacy concerns, fickleness of its users, and the danger that if it tries to monetise its service too much, users will migrate to other platforms. In fact, working out how to monetise its service has been something of an after-thought for Facebook,. You could say something similar about Google, but then Google adwords always was a brilliant concept - from day one it looked like the most cost effective advertising medium ever invented. For a long time Amazon looked constrained. After all, how much money can you ever make from selling books? The Kindle has added a new dimension to the company, because suddenly it has re-defined what we mean by a book, but even so, that's not enough to catapult the company into the next bracket.

But these days Amazon sells a whole lot more besides, and the company is emerging as a retailer to rival the very biggest in the world. As I write these words, Amazon's market cap of $81bn is around two and half times bigger than Tesco's, which is £26bn, and just under a third of Walmart's $213bn. Okay, retail is a low margin business, but Amazon has one major advantage over the likes of Tesco and Walmart; it doesn't need to carry much stock. In fact it often buys product in from customers as they are ordered. That is a massive financial benefit, which rivals can only dream about.

But what excites me about Amazon is the way in which it is benefiting from tablets and smart phones. First of all, in the US it has an app that is truly significant. It enables you to visit a traditional retail store, scan a product for sale, and then tells you what it would cost on Amazon. If you then choose to buy this product from Amazon, you get a discount. Now that is a very powerful tool. Actually, I understand there is a word to describe it; it's called Waterstoneing - based on the practise of going into Waterstones, browsing the shelves, and then buying then book you like the look of from Amazon.

But the big one is the Amazon Kindle Fire. This is the tablet that has reportedly been outselling the iPad in the US. The point about this product is that it is geared up to promote buying products from Amazon. And, by the way, it represents a real blow for Google, because the Fire is an Android phone that has disabled many of the Google apps.

The Fire is cheap. Amazon is deliberately selling it cheap, because - well, it's the old give away - the razors make money from the razor blade philosophy. And because the product is cheap, and has cost a fair bit to develop, Amazon is seeing sales rise, but profits fall. In the last quarter, revenue was up 35 per cent, profits turned into a loss. The company says it may make a loss in the next quarter too.

Of course its forward earnings ratio based on projected profits for 2012 is high; the company expects to lose money for most of this year. If you are losing money, and have a positive valuation, then does not that imply an infinite p/e value? Amazon is playing a long game.

And I have this feeling that in a few years' time, we will be buying more stuff from Amazon than any other retailer in the world.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees