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Amazon and Apple: shrinking margins, diverging prices

Amazon has undeservedly absorbed the optimism once showered on Apple . The online retailer's profit rose a bit in the fourth quarter, but its 1.9 per cent operating margin remains as slim as the justification for Amazon's valuation of 165 times expected earnings. Apple's 32 per cent margin fetches it only a multiple of 10. The discrepancy is now even harder to compute.

True, the empire built by Amazon founder Jeff Bezos is extensive, and it continues to add outposts both in the physical and virtual worlds. Amazon is building warehouses, expanding inventories worldwide, and offering new products and services for Web-based businesses every few days. Capital expenditure amounted to more than $10-billion in 2012. Meanwhile, it continues to cut prices to drive sales.

That's helped the company grow at an impressive 22 per cent rate. Yet the pace of growth is slower than it was a year ago. Moreover, the foundation of a business empire is profitability. And Amazon's still isn't stacking up. Its net margin was less than a third of Wal-Mart's. Meanwhile, its return on invested capital is steadily falling, which strongly hints at wasteful building. In 2010, the return was over 40 per cent. In this quarter it was 4 per cent.

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While it's not uncommon for investors to exhibit schizoid behavior, it's rare for such emotions to run divergently wild at the same time, as seems to be the case with the performances of Apple and Amazon. Both companies' revenue is growing strongly. However, anxiety that the iPhone maker's margins will fall over the next year, and hopes that Amazon's will continue to rise, explain why investors have sent Apple shares down more than 20 per cent over the past three months, and Amazon's up a similar amount.

With Amazon's price-to-earnings multiple standing at 16 times the ratio accorded to Apple, investors have fully baked in collapsed margins at the one and rapidly rising profitability at the other. Apple may have its challenges, but that's just bananas.

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