Amazon (AMZN 0.58%) released first-quarter earnings Tuesday night, and while the results were generally strong, they didn't please everyone.
In the wake of dividend initiations from "Magnificent Seven" peers Meta Platforms and Alphabet in recent months, some investors were hoping Amazon would follow suit and announce its own dividend.
After all, Amazon is older than both of those companies, and at a market cap of nearly $2 trillion, it could certainly afford to share some of its wealth with investors.
However, Amazon passed on the opportunity to pay a dividend, and CFO Brian Olsavsky offered a familiar explanation for why Amazon didn't plan on returning capital to shareholders. Olsavsky said: "Our first priority is to invest in, to support the growth opportunities and long-term investments within our businesses, and generally we still have many opportunities for that capital to use that would generate meaningful returns."
Founder and longtime CEO Jeff Bezos instilled a "Day One" philosophy in the company and insisted that it would invest for the long term. Amazon has never paid a dividend, and the company rarely buys back its stock. In fact, its share count has grown consistently over its history due to share-based compensation. Many of its peers have used share buybacks to offset dilution from share-based compensation, but Amazon has mostly ignored that option, and shareholders haven't complained.
However, there's a better reason than the company's philosophy for it to avoid paying a dividend. It doesn't make sense at the current valuation. Here's why.
Image source: Amazon.
Amazon's valuation doesn't support a dividend
As a stock, Amazon is different from Meta, Alphabet, Apple, and Microsoft, the Magnificent Seven stocks that pay a dividend.
Amazon has historically traded at a much higher earnings multiple, and it's only started delivering substantial profits relatively recently.
After earnings per share tripled in the first quarter to $0.98, Amazon stock now trades at a price-to-earnings (P/E) ratio of 50. That's about as cheap as the stock has been in its history, but it's still valued at a clear premium to the S&P 500 and the rest of the Magnificent Seven.
Dividends are paid out of earnings, which means that the more expensive a stock is, the less valuable its dividends are. For example, at a P/E ratio of 50, even if Amazon paid out all of its profits as dividends, it would only have a dividend yield of 2%, which is similar to the S&P 500.
Meta and Alphabet both initiated small dividends that yield less than 1%, which Amazon could have also done. But at its current valuation, the company is better off investing that income and taking advantage of 5% interest rates or any investment or acquisition opportunities that may arise.
Amazon's interest income improved from $611 million in the quarter a year ago to $993 million, and if Amazon collected 5% on the $37.7 billion in net income it made over the last year, that would translate into nearly $2 billion in interest income. That's likely more valuable to the company than paying a dividend yielding up to 2%.
Amazon will pay a dividend eventually
Amazon's valuation is coming down steadily as its earnings and margin surge. That pattern is likely to continue, as CEO Andy Jassy has focused on cost-cutting and driving profits from its high-margin businesses.
Given that approach, which reflects the maturing business that Amazon has become, the company is likely to pay a dividend eventually.
That could take years, much as it did for Meta and Alphabet. But as the company's cash balance increases and its valuation comes down, paying a dividend will only make sense for both the company and for its investors.
