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Numerous articles have been written regarding the current value (or lack thereof) of shares in Amazon.com (NASDAQ:AMZN). Despite the in-depth coverage this stock has received recently, I thought it worth my time to write about it because the stock offers so many opportunities to illustrate fundamental analysis techniques. Up until now, I've written only about free cash flow analysis and basic ratio analysis, but this time I will widen the scope a bit and look at a few more aspects that go into equity valuation.

The Surface Arguments: Pro and Con

While there have been many great arguments as to merits and faults of Amazon.com on Seeking Alpha, the majority of opinions expressed in comments seem to fall under two categories. First, the bulls seem to argue that Amazon may have earnings issues, but revenues are climbing. Any and all woes in the financial statements are a result of Amazon "investing earnings back into growth and infrastructure." The bears, on the other hand, counter that a historical P/E north of 3480 and a forward P/E of 138 is simply too much to pay for a company, no matter how rosy its prospects are.

Discount Free Cash Flow

The first step we should take before weighing in on this argument is to establish a baseline valuation. I base my valuation decisions off of a discounted free cash flow analysis (DCF). As many of the variables in a free cash flow analysis are estimates, I prefer to stay fairly conservative.

I've covered DCF in the past, and don't want to get too far in the weeds. Still, I feel it's helpful to cover a few aspects of it before presenting my findings.

First, if we are knowledgeable enough with the company's operations, competitors, and the overall industry, we could build a pro-forma spreadsheet and develop growth estimates on our own. Unfortunately, I do not have the knowledge base, nor do the few thousand dollars I'm likely to invest in Amazon warrant such a detailed look. I am forced to piggyback off analyst growth estimates.

If I go to Yahoo Finance and view analyst estimates, I can get a look at both analyst growth estimates for the upcoming years, and I can look at how close analysts came in recent years to meeting their earnings estimates. Below is a copy of the chart from Yahoo Finance, detailing future growth estimates. I also included an additional chart from Streetinsider.com with two years worth of earnings per share vs. consensus estimates. Yahoo's records only reflected one year.

Growth Est.

AMZN

Industry

Sector

S&P 500

Current Qtr.

-26.30%

43.40%

9.80%

9.20%

Next Qtr.

25.00%

54.70%

0.70%

15.10%

This Year

-100.70%

17.60%

5.20%

6.30%

Next Year

17,700.00%

18.90%

18.10%

13.20%

Past 5 Years (per annum)

-3.73%

N/A

N/A

N/A

Next 5 Years (per annum)

35.59%

11.83%

14.00%

9.04%

Price/Earnings (avg. for comparison categories)

-24,362.00

-141.19

-19.06

14.18

PEG Ratio (avg. for comparison categories)

-684.52

-3.41

0.40

0.14

Date

Qtr

EPS

Cons.

Surprise

Revs

Cons.

Estimate EPS/Revs

Gd.

% Since

Details

10/25/12

Q312

-$0.60

-$0.08

-$0.52

$13.81B

$13.92B

$0.01 / $13.97B

=

+6.8%

Details

7/26/12

Q212

$0.01

$0.02

-$0.01

$12.83B

$12.89B

$0.05 / $12.97B

=

+11.1%

Details

4/26/12

Q112

$0.28

$0.07

+$0.21

$13.2B

$12.9B

$0.10 / $12.97B

N/A

+24.8%

Details

1/31/12

Q411

$0.38

$0.19

+$0.19

$17.4B

$18.2B

$0.42 / $18.37B

=

+26.1%

Details

10/25/11

Q311

$0.14

$0.24

-$0.10

$10.9B

$10.93B

$0.35 / $11.16B

N/A

+7.6%

Details

7/26/11

Q211

$0.41

$0.35

+$0.06

$9.9B

$9.37B

N/A / N/A

=

+14.2%

Details

4/26/11

Q111

$0.44

$0.61

-$0.17

$9.86B

$9.52B

N/A / N/A

=

+34.4%

Details

1/27/11

Q410

$0.91

$0.88

+$0.03

$12.9B

$12.98B

N/A / N/A

=

+32.5%

Details

There are several notable data points in these graphs. What jumps out at me is that estimates for the next few years seem extremely optimistic. With growth rates in the negatives over the past 5 years, why are analysts so confident that the next five years will be so different? As always in life, when I have difficult questions that need answering, I turn to Google. A Google search failed to turn up anything substantial, so I was forced to turn to several research reports provided to me by my broker.

Standard & Poor's 24 November AMZN Stock Report had this to say regarding Amazon.com's future prospects:

"In 2013, we expect a slight widening in gross margins, driven by an increase in third-party sales and product mix shift, largely offset by competitive pressures. We look for operating margins to widen significantly, with an expected deceleration in investments related to fulfillment, marketing and technology infrastructure."

There it is. Analysts' (well, one at least) optimistic growth estimates seem to be based on a deceleration in the investments in fulfillment. In other words, profit margins will improve when investment in the company's ability to produce income is reduced. Now's a great time to look at the earnings history chart we pulled from Streetinsider.com. Sadly, the data only covers two years (analysts don't seem to like to keep a record of their estimates). But what a picture those years are. Earnings surprise ranged from -650% to 300%. Overall, analysts estimated earnings this past year (4q 2011 to 3q 2012) of $0.20, and the company achieved earnings of $0.07. Analysts were off this year by 285%. I think it's safe to say we shouldn't put too much faith in future earnings estimates.

Normally, I use this data to determine a discount to analysts' estimates. Often, I'll shave 10% to 25% off of analysts' estimates, based on past performance and my overall assessment of the industry. In this instance, however, analyst opinions were all over the map in terms of under or over estimating. And, since I don't have a decent sample size to determine a better growth rate, I'm going to run with their assessment.

I will use 11% as my required rate of return (discount rate), and I'll use 3% as a horizon growth rate.

Actual

Income Statement ($ millions)

2011

Net Sales

48,077

Cost Of Goods Sold

37,288

Selling, general & administrative

6,864

Depreciation/other costs

3,063

Operating profit

862

Balance sheet ($ millions)

Cash

9,576

Inventory

4,992

Accounts receivable

2,571

Total operating current assets

17,139

Net PP&E

4,417

Total operating assets

21,556

Accounts payable

11,145

Accrued expenses

2,765

Total operating current liabilities

13,910

Free Cash Flow Calculations ($ millions)

Operating Income

862

Tax on Operating Income

222

NOPAT

640

Net Operating WC

3,229

Net Operating Long Term Assets

4,417

Total Net Operating Assets

7,646

Investment in net operating assets

0

Free Cash Flow

640

free cash flow

640

growth rate in free cash flow

WACC/ or required rate of return

0.11

Horizon value

N/A

Value of operations

$23,583

Growth Rate

variable

Value of investments

0

Total value of firm

23,583

value of all preferred stock

Value of equity

23,582.8

Number of shares (millions)

452.96

Estimated Share Price

$ 52.06

In the end, even with analysts' growth rates (and a horizon growth rate of 3%), I come up with a fair value of $52.06. Obviously, this is significantly lower than the price the market has deemed worthy of bestowing Amazon shares. I have to ask what kind of changes to my formula would it take to get me to a fair value around $240? I can alter the growth rate, or I can alter my required rate of return. Everything else is based on numbers provided by Amazon, and can be presumed to be accurate.

By changing my required rate of return, I find I can calculate a fair value with a required rate of return of 4.8%. Therefore, I estimate that if analyst recommendations are correct, and if investors are not hoping to earn more than 5% return on their holdings, this stock could be fairly valued.

Examining Surface Arguments

To many bulls, a DCF analysis does very little in the way of solving whether to invest or not. Perhaps you feel the analysts' growth estimates of 17700% in 2013, and a mere 35.59% for the next five years is too conservative. In the two year sample we had available to us, we could see that their assumptions were, for all intents and purposes, random. Since you, nor I, know the future, it is not entirely irrational to assume the numbers that went into my DCF are erroneous.

Perhaps a deeper look into the company's financials may give us some insight as to how likely it is for it to exceed growth expectations.

Enterprise Earnings

At this point, further investigation should be designed to analyze assumptions that climbing revenue merits investment despite current price vs. earnings ratio. Since the bull argument states that investment will produce future returns significant enough to boost profit margins, we ought to at least attempt to value the company, taking into account investments in R&D, advertisements, and intangibles. One method, which I find quite useful, is detailed in Hewitt Heiserman Jr.'s excellent book, "It's Earnings that Count." Mr. Heiserman details the creation of the "enterprising income statement," which strives to account for the value that intangible investments bring to the company.

Detailing this method would warrant an article unto itself. Furthermore, I feel it would be a disservice to Mr. Heiserman to disclose the specifics of his methodology, given that he is selling books describing that very thing. However, here is the general idea:

Mr. Heiserman argues that investors who rely on a company's investment in R&D, patents, advertising etc. to produce value must have a way to measure the value created by those investments. GAAP accounting requires companies to expense intangibles such as R&D and advertising, rather than depreciate it, as one would do with expenditures on tangible assets. Furthermore, he argues that GAAP accounting treats shareholder equity as a free source of financing. His "Enterprise Income Statement," one of many "income statements" in the book, treats intangibles as depreciable assets, while attempting to account for the cost of issuing equity.

The calculations result in an "enterprise earnings per share" where we can view capitalized intangibles in the same light as debt and equity. The more money earned per dollar spent on intangibles, the more efficient the company. With this information, we can see trends in Amazon's enterprise EPS to see whether the business is becoming more or less efficient.

Intangibles Net Income

2007

2008

2009

2010

2011

Revenue

14835

19,166.00

24,509.00

34,204.00

48,077.00

Cost of Sales

11447

14,896.00

18,978.00

25,993.00

36,205.00

Selling, marketing and admin

1880

2,419.00

3,060.00

6,131.00

9,773.00

Other expense

0

0.00

0.00

0.00

0.00

Intangibles reversal

-$947.00

-1,220.00

-2,640.00

-2,624.00

-3,502.00

Intangibles

$564.93

713.33

1,100.53

1,472.50

1,953.00

Interest expense

$314.16

347.09

389.46

450.82

592.58

imputed interest operating leases

-7.48

-7.66

-8.47

-9.40

-14.15

taxes

184

247.00

253.00

352.00

291.00

total expenses

$13,435.61

17,394.77

21,132.53

31,765.93

45,298.43

Profit

$1,399.39

1,771.23

3,376.47

2,438.07

2,778.57

Per-share "earnings"

$3.30

$4.10

$7.64

$5.35

$6.03

enterprise P/E ratio

28.07

12.51

17.61

33.64

41.57

As you can see, enterprise earnings are significantly rosier than GAAP earnings. While there is a trend downwards from 2009 to 2011, it's nothing I would call alarming. The rise in enterprise price/earnings ratio, however, is a little more telling. Today's enterprise P/E ratio is the highest it's been since at least 2001 (I did not calculate prior to 2002). For six of the past ten years, investors have paid less than half of what they are currently paying for Amazon enterprise earnings. Investors are literally doubling down on this company's ability to turn present investments into future returns.

Ratio Analysis

Ratios give us a simple way to compare financials between one company and its competitors to get a sense of financial health and competitiveness. Ideally, one company would be compared with another in an almost identical market. The trouble with ratio analysis when examining Amazon is that the company is so large and has so many hands in different areas that it is going to be tough to define any other business as a "direct competitor." I chose three competitors because they represent "top hitters" in some of Amazon.com's business sectors. I chose the fourth company as an additional representative of an internet "technology" stock.

Ratio

AMZN

AAPL

BKS

NFLX

GOOG

Return on Investment TTM

1.58

36.94

-2.76

2.78

15.58

Return on Equity TTM

.52

42.84

-9.41

8.05

17.18

Return on Assets TTM

.76%

28.54

-1.33

1.54

13.29

Inventory Turnover

9.88

112.12

2.78

-

-

Net profit margin TTM

.28

26.67

-.74

1.26

22.20

Current ratio

1.04

1.5

1.06

1.39

3.94

debt/equity ratio

0.0

0

33.58

55.8

9.12

Sales - 5 yr growth rate

35.03

44.81

-

26.31

29.01

Earnings per share - 5 yr growth rate

25.02

62.22

-

42.53

24.52

P/E ratio TTM

3303

13.2

-

104.08

21.67

Price to tangible Book

22.33

4.86

-

-

4.57

Price to Free Cash Flow

105.69

13.23

34.47

250.99

17.94

If Amazon.com was competing with Barnes & Noble (NYSE:BKS) alone, we might be able to pack our bags right now and say "I don't care what Amazon is spending their money on, it's working!" As a business, Barnes & Noble is failing to keep up with Amazon.com in almost any measurable way. Despite leveraging debt, Barnes & Noble still records net losses as reflected in its ROI, ROA, and ROE. The five year sales growth rate is in the negatives, and Barnes & Noble's inventory turnover is downright sluggish compared to Amazon. In a world where all competitors have brick and mortar storefronts, basically one product line, and inferior web presence, Amazon prices might be justified by ratio analysis alone.

However, Amazon's internet peers look to be putting up a much better fight. Even Netflix (NASDAQ:NFLX), the short sellers' piñata, outperforms Amazon when it comes to return on investment, equity, and assets. Netflix also has a higher net profit margin (for now), and current ratio. Netflix is supposed to be an example of a company trapped in an unprofitable business model. Yet it is currently more profitable and earning more off its investments than Amazon.

Looking at the ratios posted by Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL) illustrates truly healthy companies. ROI, ROE, and ROA are all in the double digits. Both companies sport net profit margins above 20%. Both have low debt and current ratios well in the sustainable range. Google's sales and inventory growth measured over the past five years is comparable to Amazon's, and Apple's far exceeds Amazon. Yet, Amazon is valued far above both these companies, as measured against earnings, free cash flow, and tangible book value.

Common Size Balance Sheet and Income Statement

Amazon.com is one of the most examined stocks on the market. Consequently, I'd be surprised if the company is guilty of any real financial malfeasance given all the eyes on it. Still, if we are to take a look at future profitability, we would be remiss if we did not try to assess whether the company's financials hold any clues as to whether the company has any hidden skeletons, or simply whether it has any growing weaknesses.

I've mentioned Howard Schilit's book titled "Financial Shenanigans" several times in previous articles. Mr. Schilit goes into great details on various methods companies use to bolster financial statements, some techniques being merely sketchy, some being outright illegal. After defining different deceptive accounting techniques, Mr. Schilit describes a methodology to search for signs of them, including a qualitative search and a quantitative technique named Common-Size Analysis.

Common-Size Analysis is an attempt to look at a company's balance sheet and income statement in relation to total assets and total sales, respectively. The first portion of common-size analysis is vertical analysis, where all balance sheet items are expressed as a percentage of total assets and all income statement items as a percentage of net sales.

AMZN

Year

2008

2009

2010

2011

TTM

Month

12

12

12

12

Prior 4 Quarters

Income Statement

Revenues

Revenue

100.00%

100.00%

100.00%

100.00%

100.00%

COGS

77.72%

77.43%

75.99%

75.31%

76.26%

Gross Profit

22.28%

22.57%

24.01%

24.69%

23.74%

Operating Expenses

SG&A

12.62%

12.49%

17.92%

20.33%

15.40%

R&D

5.39%

5.06%

5.07%

6.05%

7.13%

Other

0.00%

0.00%

0.00%

0.00%

0.00%

Operating Income

4.39%

4.61%

4.11%

1.79%

0.93%

Other Income and Expense

Net Int Inc & Other

-.31%

-0.13%

-0.27%

-0.15%

0.09%

Earnings Before Taxes

3.37%

4.74%

4.38%

1.94%

0.84%

Income Taxes

1.29%

1.03%

1.03%

0.61%

0.56%

Earnings After Taxes

3.37%

3.68%

3.37%

1.31%

0.07%

Acctg Changes

0.00%

0.00%

0.00%

0.00%

0.00%

Disc Operations

0.00%

0.00%

0.00%

0.00%

0.00%

Ext Items

0.00%

0.00%

0.00%

0.00%

0.00%

Net Income

Net Income

3.37%

3.68%

3.37%

1.31%

0.07%

Net Income %

0.00%

0.00%

0.00%

0.00%

0.00%

Diluted EPS, Cont Ops$

0.01%

0.01%

0.01%

0.00%

0.00%

Diluted EPS$

0.01%

0.01%

0.01%

0.00%

0.00%

Shares

Balance Sheet

Assets

Cash and Equiv

33.31%

24.93%

20.09%

20.84%

13.05%

Short-Term Investments

11.52%

21.15%

26.52%

17.04%

9.93%

Accts Rec

9.95%

7.15%

8.44%

10.17%

10.48%

Inventory

16.83%

15.72%

17.03%

19.75%

22.18%

Other Current Assets

2.45%

1.97%

1.04%

1.39%

1.81%

Total Current Assets

74.06%

70.93%

73.13%

69.19%

57.45%

Net PP&E

10.27%

9.34%

12.84%

17.47%

24.80%

Intangibles

0.00%

0.00%

0.00%

0.00%

0.00%

Other Long-Term Assets

15.67%

19.74%

14.02%

13.34%

17.75%

Total Assets

100.00%

100.00%

100.00%

100.00%

100.00%

Liabilities & Equity

Accts Payable

43.23%

40.58%

42.83%

44.09%

36.65%

Short-Term Debt

0.71%

0.00%

0.00%

0.00%

0.00%

Taxes Payable

0.00%

0.00%

0.00%

0.00%

0.00%

Accrued Liabilities

13.15%

0.00%

0.00%

0.00%

18.55%

Other Short-Term Liabilities

0.00%

12.73%

12.35%

14.84%

0.00%

Total Current Liabilities

57.08%

53.31%

55.18%

58.93%

55.20%

Long-Term Debt

4.92%

0.79%

0.98%

1.01%

0.00%

Other Long-Term Liabilities

5.86%

7.84%

7.33%

9.38%

11.72%

Total Liabilities

67.86%

61.94%

63.48%

69.31%

66.92%

Total Equity

32.14%

38.06%

36.52%

30.69%

33.08%

Total Liabilities & Equity

100.00%

100.00%

100.00%

100.00%

100.00%

If we look at the chart above, we can look for structural changes. Mr. Schilit's book can guide you towards how to analyze the results, and it seems there is no limit to the depths you can plumb. However, Amazon.com's financials look fairly straightforward, and the scope of this article is in danger of growing exponentially. On a glance, two things jump out that need addressing.

The first issue I noticed was that cash and cash equivalents, as a percentage of total assets, dropped almost every year from now to 2008, with the biggest drop in the last few quarters. This is an indication that Amazon may be experiencing liquidity issues. From this observation, one may reasonably expect Amazon to borrow money in the near future, and it recently announced plans to do just that. In a company where borrowing costs are exceptionally high, and debt to equity rates are already substantial, this would be a very large concern. Amazon's almost nonexistent debt makes this much less of a concern to me. Still, potential liquidity issues are noteworthy, and are certainly not supportive of improving profit margins.

Next, I noticed a jump in net PP&E in relation to sales. When PP&E grows substantially faster than sales, an astute investor should look for signs that the company in question may be capitalizing maintenance and repair expenses to strengthen its balance sheet. Because I had used net PP&E rather than gross PP&E, I went back and reconverted to gross. The results were similar.

AMZN

2008

2009

2010

2011

TTM (prior 4 qtrs)

GROSS PP&E

16.95%

13.86%

17.32%

22.89%

unavailable

TOTAL ASSETS

100%

100%

100%

100%

Hmm… Growing "substantially" faster is definitely open to interpretation. But PP&E is increasing as a percentage of total assets, and a look into the 2011 annual statement reveals some interesting details on what constitutes PP&E. Here's how Amazon defines PP&E.

Note 3-FIXED ASSETS

Fixed assets, at cost, consisted of the following (in millions):

December 31,

_____________________________________2011____ 2010

Gross Fixed Assets (1):

Fulfillment and customer service . . . . . . . . . . . $1,633.........$ 775

Technology infrastructure . . . . . . . . . . . . . . . . 2,573..........1,192

Internal-use software, content,

and website development. . . . . . . . . . . . . . . . .643...............487

Other corporate assets . . . . . . . . . . . . . . . . . .831..............418

Construction in progress . . . . . . . . . . . . . . . . . 106.............384

Gross fixed assets . . . . . . . . . . . . . . . . . . . . .$5,786.........$3,256

Accumulated Depreciation (1):

Fulfillment and customer service . . . . . . . . . . . .364. . . . . . . 211

Technology infrastructure . . . . . . . . . . . . . . . . 610. . . . . . . .316

Internal-use software, content,

and website development . . . . . . . . . . . . . . . . .294 . . . . . . . 255

Other corporate assets . . . . . . . . . . . . . . . . . . 101. . . . . . . 60

Total accumulated depreciation . . . . . . . . . . . . .1,369. . . . . . 842

Total fixed assets, net . . . . . . . . . . . .. . . .. . . $4,417. . . . . $2,414

OK. There is some room for interpretation here, and the more I have to guess at what is capitalized, the less confident I am about what is being reported as income. The first thing I notice is a huge jump in fulfillment and customer service. Yet when I search through the annual statement for what is being capitalized under this heading, I can't find anything specific. Amazon.com DOES define fulfillment costs as the following:

"Fulfillment costs represent those costs incurred in operating and staffing our fulfillment and customer service centers, including costs attributable to buying, receiving, inspecting, and warehousing inventories; picking, packaging, and preparing customer orders for shipment; payment processing and related transaction costs, including costs associated with our guarantee for certain seller transactions; responding to inquiries from customers, and supply chain management for our manufactured Kindle devices. Fulfillment costs also include amounts paid to third parties that assist us in fulfillment and customer service operations"

Fulfillment costs, which accounted for nearly 30% of capital assets in 2011, could include costs incurred operating and staffing service centers, buying inventories, and packing customer orders for shipment? Probably not, as $4,576 million is listed under fulfillment operating expenses. We can assume that Amazon has capitalized only costs associated with expanding warehouse space, delivery trucks, etc. Unfortunately, we don't know, as Amazon has chosen not to spell out what they are capitalizing in this category.

In contrast, Amazon does offer an explanation of what it capitalizes in regards to software and website development. Still, it is up to management to decide what software for their website is "developed" and what software is for maintenance of the same website.

Internal-use Software and Website Development

"Costs incurred to develop software for internal use and our websites are capitalized and amortized over the estimated useful life of the software. Costs related to design or maintenance of internal-use software and website development are expensed as incurred. For the years ended 2011, 2010, and 2009, we capitalized $307 million (including $51 million of stock-based compensation), $213 million (including $38 million of stock-based compensation), and $187 million (including $35 million of stock-based compensation) of costs associated with internal-use software and website development."

I'm not trying to insinuate that anything criminal or even unethical is going on with Amazon's financial reporting. I'm simply pointing out that there is some degree of ambiguity as to what is being capitalized and what isn't, and therefore there is some wiggle room as to how much is being invested towards future growth. This uncertainty should be reflected in valuation by a prudent investor.

Horizontal Analysis

A second method of analysis Mr. Schilit recommends is horizontal analysis. Horizontal analysis looks at percentage change for each financial statement item from year to year. This allows us to better visualize relationships between revenues and expenses, as well as highlight areas where one of those relationships has changed. When the relationship between two entries change, we can dig deeper to find the cause.

Month

12

12

12

12

Prior 4 Quarters

2008/12

2009/12

2010/12

2011/12

Income Statement

Revenues

Revenue

129.19%

127.88%

139.56%

140.56%

119.09%

COGS

130.13%

127.40%

136.96%

139.29%

120.60%

Gross Profit

126.03%

129.53%

148.45%

144.59%

114.49%

Operating Expenses

SG&A

128.67%

126.50%

200.36%

159.40%

90.21%

R&D

126.28%

120.04%

139.84%

167.76%

140.29%

Other

#DIV/0!

#DIV/0!

#DIV/0!

#DIV/0!

#DIV/0!

Operating Income

128.55%

134.09%

124.53%

61.31%

61.60%

Other Income and Expense

Net Int Inc & Other

1180.00%

54.24%

284.38%

79.12%

-69.44%

Earnings Before Taxes

136.52%

128.86%

128.94%

62.39%

51.50%

Income Taxes

134.24%

102.43%

139.13%

82.67%

110.31%

Earnings After Taxes

135.50%

139.84%

127.72%

54.77%

6.34%

Acctg Changes

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Disc Operations

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Ext Items

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Net Income

Net Income

135.50%

139.84%

127.72%

54.77%

6.34%

Net Income %

Diluted EPS, Cont Ops$

Diluted EPS$

Shares

101.89%

102.31%

103.17%

101.10%

99.78%

Balance Sheet

Assets

Cash and Equiv

109.06%

124.38%

109.67%

139.50%

56.56%

Short-Term Investments

167.19%

305.01%

170.60%

86.40%

52.66%

Accts Rec

117.30%

119.47%

160.63%

162.00%

93.04%

Inventory

116.58%

155.18%

147.49%

155.90%

101.46%

Other Current Assets

138.78%

133.33%

72.06%

179.08%

117.66%

Total Current Assets

119.23%

159.12%

140.32%

127.23%

75.00%

Net PP&E

157.27%

151.05%

187.13%

182.97%

128.19%

Intangibles

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Other Long-Term Assets

167.48%

209.21%

96.70%

127.88%

120.26%

Total Assets

128.20%

166.14%

136.08%

134.48%

90.33%

Liabilities & Equity

Accts Payable

128.59%

155.95%

143.64%

138.43%

75.09%

Short-Term Debt

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Taxes Payable

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Accrued Liabilities

118.93%

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Other Short-Term Liabilities

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131.95%

161.61%

0.00%

Total Current Liabilities

127.79%

155.16%

140.85%

143.62%

84.62%

Long-Term Debt

31.90%

26.65%

168.81%

138.59%

0.00%

Other Long-Term Liabilities

166.78%

222.38%

127.15%

172.11%

112.91%

Total Liabilities

106.69%

151.65%

139.47%

146.83%

87.22%

Total Equity

223.22%

196.74%

130.57%

113.01%

97.37%

Total Liabilities & Equity

128.20%

166.14%

136.08%

134.48%

90.33%

The very first thing I notice when I study this breakout is the rapid growth of inventory since 2008. We could already see that inventory grew as a percentage of total assets (every year after 2008) in our vertical analysis. Now we can see that inventory has grown faster every year than revenue, cost of goods sold, and accounts payable. This probably implies the obvious, that inventory is building up. We can't be sure what inventory is building up, but if significant portions of it are obsolete (Kindle/Kindle fire), then we can expect substantial write-downs in the future.

We should also note a second anomaly. Both in 2010 and 2011, Accounts Receivable grew substantially faster than revenues. So far for 2012 "TTM," this seems to have reversed. Should the trend continue, we should look for evidence of aggressive revenue recognition, such as recording revenue too soon or granting extended credit terms to customers.

Summary

Amazon.com is a great company. I am a happy customer, who uses many of the services Amazon offers. However, I try never to let my fondness for the product dictate how much I'm willing to spend for cash flow. I am an amateur, as I'm sure some posters will point out. Nevertheless, I am not willing to invest in equity if I cannot personally find value, no matter what experts might tell me. In my research on Amazon, I have found nothing that indicates it is worth what the market is currently pricing it at.

First, DCF analysis has shown us its current and expected cash flows do not warrant a price higher than $55, and that is assuming analyst growth expectations come to fruition. Even allowing for the argument that heavy investment in infrastructure and intangibles will net future returns that justify current pricing seems to fall flat. I've run the numbers capitalizing intangibles, and Amazon still seems to be double the price it should be selling, for. P/E, forward P/E, tangible book value, P/FCF all seem high compared to healthy (and unhealthy) peers and competitors.

My analysis finds no gigantic flaw or glaring indication of fraud. But it does raise several questions. First, if Amazon's investments in infrastructure, software, etc. are supposed to raise profitability, why aren't we seeing this reflected in return on assets? Revenue growth is the standard argument, but one last look at our horizontal income statement shows us that growth in SG&A and COGS are keeping pace with revenue growth. What assurances do we have that Amazon can increase profit margins by simply reducing its investments in infrastructure?

Along those same lines, Amazon.com does seem to have a somewhat aggressive accounting methodology. For one thing, its method of capitalizing includes some intangibles and some grey spots that could open the door for hiding business expenses. It also employs FIFO, which tends to underemphasize the rising costs of inventory. Speaking of inventory, it seems to be building up, and we don't know what portion of that will have to be written off in the future. None of this is indicative of fraud, but it does inject uncertainty, and uncertainty should be discounted in the price we are willing to pay.

An investment in Amazon at these prices is a bet that every possible good thing the market has predicted for Amazon will come true. A trade at this price is a bet that everything good that the market has predicted will come true and then some. For me, hope is not a course of action. I would not purchase Amazon until it has fallen into the low $100s, or something changes that significantly enhances Amazon's profitability. If I owned Amazon at these levels I would sell it.

Of course, I may be biased. I currently hold option positions on Amazon (diagonal spreads), and those spreads benefit if Amazon stays neutral or falls. I would love to hear counter arguments to what I've presented, along with any other information that justifies purchasing this stock in the $250s.

Thank you for taking the time to read my article.

Source: Amazon Already Has Optimism Priced In, It's Fundamentally Overpriced

Additional disclosure: I am short Amazon via long put positions, hedged with short put positions.