4.2 DuPont Analysis of Amazon.com

In the last chapter, we started with concept of fundamental or accounting growth which is defined as:

Fundamental Growth = ROE * Retention Ratio

ROE is Net Income/Shareholders’ Equity and the Retention Ratio is 1 – Dividend Payout Ratio.  Since Amazon paid no dividends, the retention ratio is one, and therefore we will restrict our attention to the Amazon’s ROE. 

The DuPont decomposition of ROE is:

ROE = Net Income/Sales * Sales/Total Assets * Total Assets/Shareholders’ Equity

This decomposition rewrites ROE as the product of three terms, Profit Margin Ratio, Asset Turnover Ratio and Financial Leverage respectively. 

The following table shows the DuPont decomposition for Amazon.com over its recent history.  We will look at some of the sub-components below.

Table 1:  Amazon’s DuPont decomposition history

Note that in 2000 – 2002 Amazon had a positive ROE but both the numerator and the denominator were negative.  This is obviously is not a good sign but does reinforce the loss of over 90% of shareholder value in 2000-2001.  The trend however reflected steady improvement which was a good sign, also reflected in the stock price. 

Amazon’s financial statements allow additional information to be extracted.  For example, observe that Amazon’s Total Assets increased significantly from 1998 to 1999.  To understand why requires digging further into Amazon’s 10-K report for information provided in addition to the major financial statements.

You can use Valuation Tutor to access the historical 10-K for Amazon.  Select Amazon as the stock to analyze, and in the Information Browser at the bottom, click on 10-K and then scroll down to find the 2000 10-K (filed in March of 2001):

Amazon’s 2000 10-K filing covers the period of time ending December 31, 1999 and is usually released in the first quarter of the year. 

Item 1 of the 2000 10-K reveals:


     We significantly expanded our US distribution infrastructure in 1999 with the addition of new distribution facilities in Fernley, Nevada; Coffeyville, Kansas; Campbellsville, Kentucky; Lexington, Kentucky; McDonough, Georgia; and Grand Forks, North Dakota. We also opened two new international distribution centers, one in the UK and one in Germany. On an aggregate basis, these eight new distribution centers comprised approximately four million square feet of warehouse space. The geographic coverage of these distribution centers and their capacity have dramatically improved our fulfillment capabilities and will allow us to continue to increase our volume. The new distribution centers also give us more control over the distribution process and facilitate our ability to deliver merchandise to customers on a reliable and timely basis. We now have a total of 10 distribution centers, including our facilities in Seattle, Washington, and New Castle, Delaware.

In Item 1 they further observe that:



     We have significant indebtedness. As of December 31, 1999, we had indebtedness under senior discount notes, convertible subordinated notes, capitalized lease obligations and other asset financing totaling approximately $1.48 billion. With the sale of our Premium Adjustable Convertible Securities(TM), also known as PEACS, in February 2000, we incurred additional debt of approximately $681 million. We may incur substantial additional debt in the future. :

That is, Amazon’s investment decision had a significant impact upon its financial statements.  In particular, the expansion of assets and debt combined with a significant jump in negative income led to Amazon’s stockholders’ equity turning negative by 2000.

Armed with this background information we can return to the DuPont decomposition for Amazon and how it changed over time.

Applying DuPont Decomposition to Amazon

The DuPont decomposition lets you track three important ratios:


Asset Utilization

Financial Leverage

Each of these three items is key to understanding Amazon’s performance, especially in light of the significant warehousing investments made in 1999 that were funded by debt incurred in 1999 and 2000.


First, consider profitability.  From 1995 to 2000, there was a “dot com bubble”   where shares of internet companies rose to very high levels.  Many of these companies did not generate any profits, and Amazon.com was no exception to this, as described in a colorful manner in the Fortune Magazine article, as follows:

(FORTUNE Magazine) – A year ago, getting Jeff Bezos to talk about making money was a bit like getting Bill Clinton to define sex. Last fall, when asked when he thought Amazon.com would turn a profit, he hemmed, hawed, and mumbled something about not "missing out on the big opportunities of the Internet." Pressed further, he gave this murky response: "Look at USA Today; it took 11 years to become profitable."

Beautiful Dreamer, Katrina Brooker, Fortune Magazine Dec 18, 2000.

It turned out that Bezos was correct as the following profit margin trends show.   In the chart below you can see that the profit margin fluctuated wildly in the early years and then ultimately settled down into a more normal range.  Table 1 reveals how negative net income was.  However, by 2002 Amazon’s profit margin is signaling a significant change.  It ultimately stabilized in the latter the latter part of the decade.  

Amazon’s profit margin behavior suggests that the 1999 asset expansion ultimately proved to be worthwhile for Amazon’s shareholders. 

Asset Turnover

The second major term in the DuPont decomposition asks: how efficiently assets are being utilized in the company.  The Asset Turnover ratio is calculated by dividing Sales Revenue by Total Assets.  This ratio provides insight into how efficiently assets are being utilized to generate sales revenue.

The chart reveals a positive trend over the early years.  That is, Amazon appears to be learning to utilize its assets more efficiently during the first decade of the 21st century.  This graph strongly reinforces Amazon’s decision to expand its warehousing capability in 1999 as this proved to be important for supporting the growth in sales exhibited by Amazon (see Table 1).  In addition, the combination of the positive asset utilization trends with the positive trends in profit margins provided even stronger reinforcement of the investment decision made in 1999 and it was not until the economic crisis of 2008/2009 that any real change in trends occurred.

However, the investment decision did add a considerable amount of debt to Amazon’s Balance Sheet and so the third major component of the DuPont decomposition provides insight into how this is reflected in the financial statements.

Financial Leverage

Finally, ROE is the product of ROA and Financial Leverage and financial leverage reflects Amazon’s debt policy.  Financial Leverage only makes sense for firms that have positive shareholders equity and so the blanks parts in the graph below correspond to the times Amazon had a negative shareholders’ equity. 

Recall that Amazon introduced some significant debt when it invested in its own warehouses.  For example, Amazon’s 2000 10-K reveals that from 1998 to 1999 Amazon’s debt increased significantly:

                                   1998                  1999                2000

Long-term Debt        348,140          1,466,338      2,127,464

The increasing debt, combined with increasing losses, drove Amazon’s shareholder equity to be negative.  It took until 2005 before Amazon recorded a positive shareholders’ equity and the graph depicts a significant improving trend in financial leverage as Amazon was building up retained earnings and paying down its debt.