Amazon (AMZN) has the third largest market cap in the stock market. Its market cap marginally crossed the $1.0 T threshold a few months ago and now stands at $731 B due to the recent correction of the stock. This market cap is only slightly lower than the market cap of Microsoft (MSFT) and Apple (AAP). As these two tech giants have been paying dividends for years, it is only natural that some income-oriented investors wonder when Amazon will initiate a dividend?

Business overview

Amazon offers a gigantic e-commerce platform, which lets consumers purchase almost everything with their computers or smartphones. Amazon operates in three segments: North America, International and Amazon Web Services. The first two segments include the global retail platform of consumer products while the third segment provides cloud computing and storage services to consumers and enterprises.

Growth

Amazon has consistently grown its revenues at an impressive pace every single year for more than a decade. During the last decade, the company has grown its revenues more than 10-fold, from $19.2 B in 2008 to $221.0 B in the last 12 months. Notably its earnings performance has been extremely volatile. Between 2008 and 2015, Amazon did not grow its earnings per share, which remained at an almost negligible level.

The vast majority of the companies that are listed in the stock market make great efforts to grow their earnings per share consistently and thus satisfy the analysts and their shareholders. Amazon is a great exception, as it has not paid any attention to its bottom line results. Instead the online giant has always focused exclusively on the long-term growth of its earnings. This focus has begun to bear fruit in the last three years. During this period, Amazon has grown its earnings per share more than 10-fold, from $1.25 in 2015 to an expected $19.79 this year. Even better, there are absolutely no signs of fatigue, as the online giant is expected to grow its earnings per share by another 35% next year, to $26.69.

Cash flows

When evaluating the ability of a company to distribute a meaningful dividend, it is paramount to check its free cash flows, as dividends are funded from free cash flows. Due to the fierce competition in the tech sector, tech companies are obliged to spend excessive amounts on capital expenses every year in order to remain ahead of the game. Technological progress is so fast that it can render the high-tech companies of today obsolete tomorrow. Apple was on the verge of bankruptcy two decades ago and now has the second largest market cap in the world. Some tech companies spend excessive amounts only to maintain a flat performance.

Amazon has always spent huge amounts on its business in order to remain ahead of the game. Until three years ago, its capital expenses consumed a great portion of its operating cash flows and hence its free cash flows were suppressed. However, in the last three years, its profits have grown so much that they have greatly enhanced its free cash flows. To be sure, its free cash flows in the last 12 months have jumped 93% over last year, from $8.0 B to $15.4 B. As a result, the company certainly has the ability to initiate a dividend.

However, investors should note that Amazon is a high-growth stock and hence it is trading at an extremely high price-to-earnings ratio. Even after its recent 27% correction, the stock is trading at a price-to-earnings ratio of 75.5. This exceptionally rich valuation has the following implication; even if the company distributes all its earnings to its shareholders in dividends, it will offer a modest 1.3% dividend yield.

Moreover, it cannot distribute all its earnings as it has to spend huge amounts every year in order to remain ahead of its competitors. If it chooses to distribute 30% of its earnings, it will offer just a 0.4% dividend yield, which is meaningless to investors. High-tech companies should not pursue a higher payout ratio because they will impair their growth potential in this way. To cut a long story short, Amazon enjoys such a rich valuation thanks to its high-growth profile that it cannot distribute a meaningful dividend to its shareholders.

Final thoughts

After several years of volatile earnings performance, Amazon has grown its earnings and its free cash flows at an impressive pace in the last three years. However, thanks to its admirable performance, the stock is trading at an exceptionally rich valuation. As a result, even if it decides to distribute a significant portion of its earnings to its shareholders, its dividend yield will be essentially negligible. Therefore, the online giant will not initiate a dividend, at least for the next several years.

Shareholders should not be disappointed by the absence of a dividend. In fact, they should wish for the absence of a dividend for as long as possible. Whenever Amazon initiates a dividend, it will essentially signal that it does not need to reinvest enormous amounts on growth projects anymore and hence its high-growth phase is approaching an end. That will undoubtedly be a negative development for its shareholders. Fortunately for the shareholders, Amazon still has immense growth potential and thus it will not initiate a dividend for many more years.