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Latest Comments7 Comments
Who Says Amazon's Margins Are Rising?
Obviously, you didn't actually look at Amazon's results relative to their guidance for operating income in coming up with your conclusion. I guess it's easier to just make up facts as opposed to looking it up.
Q1 2008 - guidance ($155m-$200m) vs. actual ($198m)
Q4 2007 - guidance ($221m-$291m) vs. actual ($271m)
Q3 2007 - guidance ($75m-$110m) vs. actual ($123m)
Q2 2007 - guidance ($65m-$105m) vs. actual ($116m)
Q1 2007 - guidance ($82m-$122m) vs. actual ($145m)
Who Says Amazon's Margins Are Rising?
It should be noted that since hitting bottom in Q4 2006, Amazon's trailing-twelve-month operating margin has risen steadily from 3.64% to 4.44%.
> Using Amazon's own midpoint guidance, we should expect second quarter operating margins to come in around 3.52%.
Amazon also consistently beats the midpoint. In fact, since Q4 2006, Amazon's operating profit has averaged within 2-3% of the highpoint of their guidance.
Amazon: Is 'Free Cash Flow' More Important Than Net Income?
Very well put. You explain it a lot better than I. KingCPA is just repeating what he wrote in his earlier post on the exact same subject. I tried my best to explain why his ideas are wrong, but got nowhere. You can read the thread here.
seekingalpha.com/artic...
Is Amazon's Free Cash Flow Overstated?
Compare 2 businesses that sell the same amount of goods at the same prices and produce the same income. Everything is the same except for the amount of inventory each company needs to operate.
Company A needs 30 days of inventory to operate.
Company B needs 120 days of inventory to operate.
Both companies have the same payment terms with their vendors - 60 days.
Let's say 60 days of AP is equal to $100m.
Company A needs 30 days of inventory, so its inventory is $50m.
Company B needs 120 days of inventory, so its inventory is $200m.
Now both companies double sales and everything else doubles as well.
For both companies, AP increases from $100m to $200m.
Company A inventory increases from $50m to $100m.
Company B inventory increases from $200m to $400m.
For company A, vendors provided an additional $100m of goods, but since its inventory only grew by $50m, the remaining $50m is available as cash.
For company B, vendors also provided an addition $100m of goods, but since it's inventory grew by $200m, it had to use $100m of its own cash to fund the growth of inventory.
This continues as they grow. Company A keeps having more cash available. Company B keeps having to put more cash into inventory.
So even though they sell the same amount of stuff and make the same income, company A has a lot more free cash than company B.
And it's not because company A is not paying it's vendors. Company A has the same AP and paying it's vendors the same as Company B.
The difference is simply that company A converted inventory into cash much faster than company B.
The free cash flow difference came from the difference in inventory.
So even though their earnings are the same, these 2 companies have very different free cash flows and very different valuations.
But the author of the article above wants you to believe that these companies have the same free cash flow and therefore the same value. He's nuts.
Is Amazon's Free Cash Flow Overstated?
Sorry, you can tilt at this windmill all you want. But no one in their right mind would equate earnings with free cash flow - certainly not Warren Buffet no matter how hard you try to attribute that equation of owner's earnings with free cash flow to him.
As for Amazon's build up of accounts payables in Q4 followed by the pay down in Q1, Amazon has always reported free cash flow as a trailing 12-month figure simply because of the seasonal effects on Amazon's free cash flow. By using a trailing 12-month figure, Amazon's free cash flow always includes a large negative FCF in Q1 to go along with a large positive FCF in Q4.
Also, if Amazon simply changed their fiscal year to end on Jan 31 instead of Dec 31, their seasonal fluctuation in quarterly FCF would be eliminated. But their total FCF would still be the same. So there's nothing wrong with the current FCF definition used by Amazon and every other company out there.
Anyway, I think I've explained this pretty clearly. I'll leave it to the readers to decide what they think is right.
Is Amazon's Free Cash Flow Overstated?
You can argue whether earnings is a better measure than free cash flow, but you can't define free cash flow to be earnings.
Free cash flow has to be a measure of cash. If you change it to measure earnings, then it would serve no purpose.
Arguing that free cash flow could be manipulated by pushing out payable is no different than arguing that earnings could be manipulated by making accounting entry adjustments.
But free cash flow is far more difficult to manipulate since it tracks real cash. You could delay paying your mortgage for a few days to push it into the next month, but then you'd have 2 payments to make in the following month. The "extra" FCF would quickly be reversed by negative FCF in the following month.
The correct definition of free cash flow is operating cash flow minus capital expenditures because it measures the amount of real cash that became available and also when the cash became available.
It then allows valuing a company based on discount cash flow which takes the amount of free cash flow a company generates and discounts them based on when the cash became available.
The reason earnings can't be used in place of free cash flow is because earnings makes no distinction as to when the cash from the earnings is received or becomes available. You can report earnings today and not have any cash associated with the earnings for 10 years or 20 years or forever in some cases.
Defining free cash flow as earnings is nothing short of idiotic and would make discount cash flow calculation impossible.
Is Amazon's Free Cash Flow Overstated?
Trying to argue that "Net income plus depreciation less capital expenditures" is a better or even useful definition of free cash flow is downright stupid.
Using that definition, increasing amounts of cash tied up in inventory would be counted as free cash flow.
It would also count increases in account receivables where the companies hasn't yet received payments for the revenue and income it has reported as free cash flow.
In other words, using the definition championed by the author, free cash flow would not track cash at all.