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What is Driving Amazon's Stock?

Being in the heart of earnings season, every day we see more companies take their chance to impress analysts, and yesterday Amazon.com (AMZN) too the stage. Judging by the stock's 5.5% jump today, you would assume that the company had blowout earnings… but you would be wrong.

Inexperienced traders often operate under the assumption stocks rise on better than expected earnings, and sell off on earnings misses, but this is not always the case. Take for example Apple (AAPL) which easily outpaced its quarterly earnings estimate last week, and saw a 10% drop in the stock the following day.

Look at the numbers:

Going into last night's earnings report, analysts had forecast Amazon to report $0.28 per share. Actual results came in under expectations at $0.21. Going into last Apple's earnings last week analysts forecast $13.47 per share, and the company posted actual earnings of $13.87.

Amazon soared on its earnings miss, and Apple sold off sharply on its earnings beat. We are not going to get into Apple's earnings, but the real question is why is Amazon trading so strongly today despite its earnings miss.

The simple answer is forward expectations. Amazon is the undisputed market leader in one of the biggest and fastest growing markets… e-commerce. Online shopping has been growing at a tremendous rate, and Amazon is more often than not the fist site people visit when searching for a product. You can buy just about anything on Amazon's site, and typically at a price lower than you can find anywhere else.

The company has been investing heavily in the future, and yes this is having an impact on current earnings, but it would be incorrect to not see how its recent investments will pay out big down the road.

Consider the Kindle Fire. The company wanted to transform its old school e-reader into a full blown tablet, and it did so with the Kindle Fire. Powered by Google's (GOOG) Android operating system, the Kindle Fire rapidly found success and is currently the best selling Android tablet.

How did Amazon penetrate such a competitive market with such ease? Simple… it sold the tablets at a loss. This hurt earnings. But the company's long term approach was brilliant. It knew that the Kindle Fire would be a powerful point of sale device for the company, so it was more than willing to sacrifice earnings today in exchange for higher margin earnings in years to come. The margins on delivering digital media are so much higher than what they could earn jacking up the pice on the tablet itself that it makes good sense to postpone the earnings.

With digital media there is virtually no storage or delivery costs, and the economy of scale makes them highly profitable once enough users are downloading the content. Amazon's goal is to keep users inside its network, and getting millions of Kindle Fires in hands of users accomplishes this with perfection.

Also, consider the company's operating income. During the fourth quarter, operating income rose by 56%. This is a huge jump for any company, but is especially impressive considering how big Amazon is. It is very difficult for a company of Amazon's size to pull off such an impressive move, and yet it did.

Its eBook business is also booming. This comes as no surprise considering how many Kindle tablets have been sold, and Amazon saw a 70% jump in eBook sales last year.

And finally, we need to just look at expected earnings growth. During 2012, the company's EPS was basically 0. By 2014, its earnings per share are expected to be around $5.00. Its earnings growth alone warrants a bullish stance on the stock.

In conclusion, Amazon is growing, is the leader of a market with very high barriers to entry, and has the type of leadership to take it to the next level.

All signs are pointing towards further gains for Amazon investors, despite of a weaker than expected fourth quarter.

You can read the full fourth quarter release here.

Disclaimer: The author of this article has a long position in Amazon (AMZN).

Michael Fowlkes

Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va.