Over time, dividend stocks tend to produce better total returns than the broader market. Strong, long-term evidence of this phenomenon can be seen when examining the Dividend Aristocrats, a group of companies that are in the S&P 500, and have increased dividends for at least 25 consecutive years. In addition to strong performance during bull markets, the best dividend stocks tend to outperform during corrections and bear markets as well, offering increased safety over the broader market. However, companies that are still in their growth stages or ones that do not pay dividends don’t enjoy the same characteristics. One such company, which we’ll look at in this article, is Amazon.com, Inc. (AMZN).
Amazon has undoubtedly been one of the best growth stories in the history of business since its humble IPO in 1997. Indeed, since that time, shares have returned nearly 100,000% to the earliest investors compared to just under 200% to S&P 500 holders. However, Amazon tends to experience much more volatility – both to the upside and downside – than a high-quality dividend stock would, so investors must understand what they’re getting into before buying. In addition, we believe it is very unlikely Amazon will pay a dividend anytime soon, so these characteristics will almost certainly remain in place for a long time to come.
Business Overview And Financial Analysis
Dividend stocks are made when a company – typically one that is large and at the mature stage in its life cycle – produces more cash and earnings than it needs to run the business. This is a normal part of the life cycle of a successful company, but some companies reach their growth potential far earlier than others, meaning they simply don’t have much to do with the excess cash that is generated. That is when companies typically begin paying dividends to shareholders.
However, growth companies like Amazon constantly invest in the business in order to fuel the next leg of expansion. Where other companies would have been happy to dominant book retailing, or even online general retailing, Amazon is seemingly never satiated. It is moving into healthcare, television and movie production, and has been a cloud services provider for years now, just to name a few of non-retail business lines. That means it is in constant need of more and more cash in order to continue to fuel that growth, so its odds of paying a dividend anytime soon are very low; it needs that cash internally.
Amazon’s recent third quarter earnings report showed continued strong growth in all of its segments. Total sales were up 29% during the quarter, led by strength in all segments. North America’s revenue increased 35% during the quarter, International revenue was up 13% and Amazon Web Services surged 46%. Profitability, a key tenet of dividend-paying stocks, is improving for Amazon as well. Operating income in the North America segment soared from $112 million in the year-ago quarter to just over $2 billion this year. The International segment improved its loss from $936 million in last year’s Q3 to $385 million this year. Finally, Amazon Web Services posted 77% operating income growth to $2.1 billion in this year’s Q3. As we can see from Amazon’s recent numbers, growth is still very much alive and well, and with massive investments in all kinds of businesses, Amazon certainly isn’t taking its foot off the gas.
While profitability and revenue growth are nice, Amazon is very much interested in another metric: free cash flow.
Source: Q3 earnings slides, page 3
This chart shows the growth of the company’s trailing twelve months free cash flows, which have risen a massive 93% year-over-year. Amazon needs this cash to continue to acquire companies for its next stages of growth, as well as build out existing lines of business for more scale.
That is evident in this slide, which shows the same free cash flow numbers as above, but with payments for finance lease repayments and assets acquired under capital leases removed.
Source: Q3 earnings slides, page 5
Despite the massive rise in free cash flow, Amazon has struggled to cover its growth via internally generated cash alone. Amazon has taken on some long-term debt in recent years to fund these expansions, although its very reasonable at ~$25 billion. Still, despite the company’s stated goal of optimizing free cash flow, it is very clear that Amazon has no excess cash being generated that could eventually be used to pay a dividend so long as it continues to invest so heavily in the future. Could Amazon pay a dividend today? The answer is very clear that it could. However, the company’s operating history and growth goals mean that any dividend payments are likely many years away as it prefers to use its sizable free cash flow for growth investments instead of shareholder distributions.
Amazon Will Be A Growth Stock For Years To Come
Investors can generally be bucketed into three groups when looking at prospective investments. There are growth stocks, value stocks, and dividend stocks as a general rule, and certainly some stocks fit into more than one of those buckets at a time. Amazon firmly fits into the growth category but has never been a value stock or a dividend stock, and based upon its stated goals and use of free cash flow, it is likely to be many years before either of those characteristics would apply.
Amazon trades with some eye-popping valuations – it goes for 85 times 2018 earnings estimates today – and that is certainly not an unusual valuation for this stock. In addition, the weight of the evidence is quite clear that Amazon has no interest in paying a dividend anytime soon.
That doesn’t mean that it couldn’t pay a dividend. Indeed, it is producing more than $15 billion in free cash flow annually today, and that number is only expected to grow. With the core North America retail business continuously improving profitability as well as the outstanding Amazon Web Services business growing by leaps and bounds, there will certainly be enough cash generated for Amazon to continue to grow. However, Amazon will be a growth stock for many years to come because of this and thus, isn’t likely to become a dividend stock for a very long time.
That being said, there are other reasons to buy Amazon shares instead of writing them off simply because they don’t offer a dividend. The company is still growing like a startup despite being one of the largest companies in the world, and its segments are constantly improving profitability while still growing revenue on a huge scale.
However, only investors with a long time horizon and a high tolerance for risk should buy Amazon shares. It tends to trade with a beta value of ~2, meaning it is twice as volatile as the broader market. That works both to the upside and downside, so during bull markets the stock performs very well. However, that additional beta works to the downside as well during tough times, so investors must be prepared to take that risk. Amazon has many positive characteristics but as we see it, investors will have to wait many years for a dividend payment from the ecommerce giant.