How to Create Value Without Earnings: The Case of Amazon

Investors and commentators often equate GAAP accounting metrics, especially earn-ings per share, with financial success. The reality, however, is that there is no simple, linear relationship between GAAP earnings and intrinsic value, which is defined as the present value of expected future cash flows. And adjustments of GAAP metrics, though admittedly subjective, are often required to understand the economic reality of a business. Amazon. com Inc. provides a case study that throws into sharp relief the need to look beyond GAAP in order to analyze underlying fundamentals and value. In this paper, the authors argue that Amazon has done a superb job of building shareholder wealth, all the while reporting low and declining operating and net income margins. The article provides a framework for thinking about Amazon's underlying profitability that is based on the concept of return on capital in relation to the cost of capital, and shows how that profitability has been masked by GAAP accounting. The authors demonstrate that the company is now investing very large amounts of capital with the expectation of earning rates of return well above its cost of capital. And their analysis suggests that if such investment can continue over the long term, Amazon's current market value of $140 billion can be readily justified.