Look Past Amazon's Earnings to What Will Really Drive the Company

Before the market opened on February 1st, Amazon AMZN posted some terrible earnings which led to an immediate price drop of 12%. The company reported $0.38 per share in this fourth quarter versus $0.91 in the same quarter last year. What does this mean for you as an investor? Should you avoid Amazon or jump into the fray?

Take a Second Look at the Numbers
Look again - the numbers Amazon posted are not as bad as you might have first thought. Yes, they did poorly in regards to net income, but there is much more to a company than a simple earnings number. Note that their sales increased by 35% between comparative quarters from $12.95 billion to $17.43 billion.

Revenue is the backbone of earnings growth; without it, you are merely tightening the belt. The revenue growth of Amazon is relentless when you look at comparative quarters. The previous four quarters have the following year-over-year revenue growth to the tune of the following percentages: 43.9%, 51%, 38.2%, and 36%.

The price-to-sales ratio now sits at 1.85 whereas eBay EBAY is at 3.5. What does this all mean? At the moment, it speaks to a value ratio that is probably being passed over due to earnings falling off a cliff. What is the problem, and will they rebound?

Amazon Creates Incentives to Gain Customers
To understand how Amazon is steadily gaining new customers, compare their business model to that of a company that sells printers. To move units and gain customers, companies that manufacture printers will hook you with a cheap printer for $30 that comes with all the bells and whistles. However, when it comes time to buy ink cartridges, you realize where their money is being made. Companies can afford to practically give away printers knowing that they will reap huge profit margins on the ink.

Amazon is being purposely secretive about how many Kindle e-book readers and Kindle Fires they are selling. Jeff Bezos, founder and CEO of Amazon states, "Our millions of third-party sellers had a tremendous holiday with 65% unit growth and now represent 36% of total units sold."

By further investigating the highlights of the earnings report, we see that "during the nine-week period ending December 31st, 2011, Kindle unit sales, including the Kindle Fire and e-reader devices, increased 177% over the same period last year." Just wait until the sale of books and movies associated with Amazon's devices begins to ramp up. That will be their "ink," and the short-lived drop in earnings will seem like a brilliant tradeoff for securing its empire.

Amazon Continues to Innovate
Amazon has made another bold move by loaning books through Amazon Prime. While many authors are not pleased by the concept of book loaning and renting e-books online - namely, sharing a fixed royalty pot with other authors based on the amount of times a book is rented - it just might be the way of the future. We rent movies in addition to buying them, so why not books?

Authors who dislike this new trend may begrudgingly get on board, as it could actually earn them more revenue. More literacy and more books being read means more money in the pockets of Amazon and authors - the program shows promise.

Final Thoughts
Make no mistake, Amazon is aggressively pushing their products at rock bottom prices to get them into people's hands. Once consumers become enamored with devices, money starts to roll in. To understand Amazon's potential, simply look at their revenue growth. Once this rapid deployment phase is over, it may already be too late to grab some shares of Amazon at a decent price.

Do your own studying and make up your own mind as to whether you believe Amazon is worth your time and money. However, I think that in the coming months, the average investor will catch on that the earnings numbers during the next year will be fairly immaterial to the bigger picture. Let the naysayers point to the earnings-based valuations that appear high - their tune will change when the second wave of this Amazon model comes to fruition and creates incredible value in a short period of time. These same naysayers will start buying when you are already up 50% for the year, as you had the foresight to buy low.

Kurtis Hemmerling is a full-time trader and blogger for Money Crashers Personal Finance, where he shares his strategies for stock investing and money management.