This One Key Metric Says Amazon.com, Inc. Is Well On Its Way To Profitability

Amazon.com, is one of the more mystifying companies in the business world today. It is disrupting seemingly every industry it can reach from retail to book publishing to cloud computing and delivery. Sales have been unstoppable since the company's inception in 1994. Last year, it grew revenue nearly 20% to $89 billion, however it still reported a net loss of $241 million for the year. Following its most recent earnings report, the stock soared as results topped analyst estimates, but with a market cap near $178 billion and no profits last year, the company is an anomaly on Wall Street as no other publicly traded enterprise is anywhere near as valuable with a similar lack of profitability. Its balance sheet has less than $2 billion in retained earnings, the best measure of accumulated profit over a company's history.

CEO Jeff Bezos has made a mantra out of "long term" and so far the market has kept faith in him. With its tentacles wrapped up in several different industries, Amazon could either turn its competitive advantages into huge profits, or the paradigm could shift and outside competition prove too fierce, forcing a slowdown in sales growth before profitability arrives, which would crush the stock price. The debate continues to rage about Amazon's future prospects, but at least one meaningful indicator is signaling that the company is taking significant steps toward profitability.

From 2011 to 2014, gross margin and gross profit improved significantly as the chart below shows.

Source: Amazon.com SEC Filings

As you can see, gross margin improved incrementally each year from 22.4% to 29.5%, and along with it gross profit jumped nearly 150% from $10.8 billion to $26.2 billion, which is much faster than the 85% total revenue growth in that period. Amazon, however,downplays the importance of those figures, saying, "We believe that income from operations is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services."

Despite that statement, the increasing gross margin offers perhaps the best evidence and insight into the ways the company is changing and how it's moving closer to profitability.

What is gross margin and why is it important? In accounting terms, gross margin is the percentage of revenue left over after deducting the cost of goods sold -- the costs directly associated with the sale of a product or service. Essentially, gross margin represents the money that is left over after variable costs are taken care of. The remaining gross profit can then be spent on fixed costs or investments, returned to shareholders, or hoarded on the balance sheet.

Amazon attributes its gross margin expansion "primarily due to service sales increasing as a percentage of total sales. Service sales represent third-party seller fees earned (including commissions) and related shipping fees, digital content subscriptions, and non-retail activities such as AWS, advertising services, and our co-branded credit card agreements." Each of those categories represent more profitable revenue streams than its core bottom-dollar e-commerce business.

As gross margin has increased, the percentage of expenses for fulfillment, technology and content, and marketing, which better reflect fixed costs, have increased.

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This One Key Metric Says Amazon.com, Inc. Is Well On Its Way To Profitability