Amazon Vs. Retail ETFs: Not So Easy

November 29, 2017

Holiday shopping season is upon us, and this year, it's hard not to be captivated by the slow-motion apocalypse happening in the retail sector. Already in 2017, 35 large retailers have filed for bankruptcy, while some 6,800 brick-and-mortar stores have closed. And the year isn't over.

Amid this industry earthquake, only two retail ETFs have notched gains: the $140 million Amplify Online Retail (IBUY) and the $53 million VanEck Vectors Retail ETF (RTH), which have risen 36.8% and 11.1% over the past 12 months, respectively.

All other retail ETFs have lost money. With a 2.6% decline, the liquidity-weighted $1 million First Trust Nasdaq Retail ETF (FTXD) has dropped the least, followed by the multifactor $14 million PowerShares Dynamic Retail Portfolio (PMR), at a 6.3% fall.

The largest fund in the space, the $523 million SPDR S&P Retail ETF (XRT), fell 9.5%, while the greatest underperformer was the $35 million Direxion Daily Retail Bull 3x Shares (RETL), a leveraged fund that tracks the same index as XRT, and which plunged 35.4%.

E-commerce Tail Winds

For the two retail ETFs that actually made money in 2017, e-commerce was key. RTH has a sizable weighting in Amazon (18.6%), whose stock price has risen 50% year-to-date, and a meteoric 400% over the past five years (see: “Big Differences In 3 Biggest Retail ETFs.”)

IBUY, meanwhile, holds only a small weighting in Amazon (3.5%), but e-commerce is the lifeblood of the fund; IBUY tracks a basket of e-commerce companies that make 70% or more of their revenues online.

Performancewise, however, no retail ETF can beat just directly investing in Amazon.

Amazon At The Heart Of Change

Over a one-year period, Amazon outperformed all retail ETFs by double digits. In fact, the stock creamed RETL by a whopping 89%:

 

Source: Bloomberg.com

 

Once you factor in the costs of investing in ETFs—annual expense ratios, spreads, tracking error, trading commissions (none of these ETFs listed trade commission-free—the diversified retail exposure these ETFs offer seems less like a smart and sensible approach and more like tossing your money on a bonfire. Even IBUY leaves 17% on the table, just by including in its basket 39 other stocks that aren't named Amazon.

Numbers like these might lead some investors to conclude they should just ditch the ETF wrapper for Amazon stock. Yet that would be a big mistake, because in this case, Amazon's outperformance is a red herring.

Tech Firm In Retailer's Clothing

For starters, Amazon isn't a pure-play retailer. Though everyone knows Amazon for its online marketplace, the company's real growth driver, at least according to its Q3 earnings report, is its cloud computing division, Amazon Web Services (AWS).

AWS, by far the dominant player in the cloud computing space, is the company's most profitable division, and it finances the investments Amazon makes in other, less profitable, business lines—such as its signature e-commerce division.

Amazon's other major nonretail-oriented business lines include Amazon Video and Twitch, both video streaming services; Amazon Studios, a television and movie production company; and Alexa, a voice-enabled digital assistant. Amazon even owns a series of wind farms across the U.S. Amazon is a tech company—or maybe a conglomerate—in retailer's clothing.

Although Amazon's retail operations remain its largest division, they aren't nearly as profitable as AWS; in fact, operating profits fell last quarter across the company's core businesses, including its online marketplace, such that Amazon's total operating margin was just 0.8%.

Other retailers don't have a cloud computing division to boost their revenues and pad their margins. Their poor margins are out in the open for all to see.

 

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