Amazon's Rich Valuation Defies Logic

it is simply startling Amazon (AMZN) can trade in this dire economic climate with a whacked out valuation of 46 times 2009 estimates. If you contrast AMZN’s multiple with its primary competitor‘s valuation, EBAY, at only nine times 2009 earnings estimates - it is obvious, either AMZN is way overvalued or EBAY is way undervalued. I think a little or a lot of both apply. I realize the Bulls will contend this vast difference in valuations is because AMZN is growing its earnings while EBAY is not, but in truth, AMZN’s projected earnings increase from 2008 to 2009 is expected to be flat at best. This company has recently been acting akin to a monopoly - but AMZN is no monopoly, it is merely a retailer disguised as a superstar of high tech internet giants. But even superstars have to rest, and AMZN is no exception.

The stock is a good short: I said it before and I’ll say again. AMZN is a screaming short! The shares exploded to the upside by more than 11% in the last three trading sessions alone due to a monster one day market rally and the effects of a Piper Jaffray upgrade (the firm was impressed by a positive customer service survey). I liked the shares as a short play at $61, but love them even more at $68. Why? Because they are now even more expensive, and with each analyst upgrade, higher expectations emerge. The bar keeps getting raised, making it tougher and tougher for AMZN to jump over. Crazy as it seems, the fact is AMZN has added more to its market cap in the last three days, than it will earnings will produce, in its next 1460 days combined. I guess the “greater fool theory” is still alive and well.

Potential land minds are numerous: Increased competition, a stronger US dollar and operational snafus could all land a fly in the ointment. Recent strength in the US Dollar could hurt especially, as AMZN derives 53% of its revenues from outside the US. So far, the execution of its business plan has been nearly flawless, but this operational excellence could set the stage for a fall. The company’s gross profit margin of 20.1% has continually gotten skinnier, as AMZN’s mindset of sacrificing margins in exchange for market share could come back to haunt it.

Formidable competition in the winds: EBAY just announced it is revitalizing its game to the next level in order to better compete with AMZN. Brick and mortar retailers such as WMT, Best Buy (BBY) and Costco (COST) are all committing additional resources to “juice up” their online sales divisions. This refinement of their web sites, as well as the emerging of new players in AMZN’s space could present AMZN with significant challenges in the future.

Stock has doubled in four months: The shares have literally doubled from their November lows, representing a “over the top” APR of 300%. Clearly it's too much, too fast, creating a very overbought condition. It is logical to deduce a correction is imminent, with a 50% retracement probable, due to a needed correction resulting from a good dose of profit taking. A drop to the $50 mark seems reasonable, giving the shares a more realistic multiple of 33 times 2009 earnings estimates of $1.48. AMZN is expected to grow its earnings in 2010 by 29% to $1.91. This generous estimate gives the company a more realistic forward multiple of 36, but the question is: Can Amazon achieve it? It all depends on Kindle’s success, if it stumbles, AMZN will not make its numbers. In all fairness: the shares should of never fallen as low as they did in first place, but the markets tend to go overboard in both directions. Let’s face it, the market is made up of human beings, and human beings are not rational. They tend to let fear and greed cloud their thinking, continually making one bad decision after another.

Bottom line: The stock is expensive. It is a good short because it is one of the few stocks left that has not already been decimated. In other words, AMZN still has plenty of water left to be drained, and stock’s notoriously tend to fall at a much quicker pace in fear, than they rise in elation. Why not make a bundle when the bottom falls out of this bucket?

Disclosure: Short AMZN.

Comments

[alancelt:]

I fully agree with this evaluation. The other thing that could hurt Amazon badly is sales tax. So far they have managed to escape paying sales tax in most states outside their base. With the recession biting, States will be looking at ways to boost their income and internet sales tax must be high on the list. Technically however the stock came out of an inverse head and shoulders formation so perhaps has an upside potential to around $85. If it gets there I would be going short again.

Mar 12 06:35 AM

[Harry Tuttle:]

I agree with your evaluation. However, in the perverse world of short selling, the fact that it is such an obvious short makes it a crowded trade.

In the end, Amazon may have to surprise everyone with huge earnings in the face of deteriorating consumer spending or will trade in-line with other retailers. In either case it may take some time.

Mar 12 08:02 AM

[User 224477:]

hmmm a relative outperformer in a bad market- with shorts getting frusturated with valuation.. Love it, Ill buy on next dip

Mar 12 08:04 AM

[Mark Krieger:]

Good point about the tax issue, you indicate a potential move to $85 on the high side, but you fail to mention AMZN's downside risk; I contend that the downside is roughly twice as bad as the upside potential-there is $30 downside risk and only $15 potential reward, creating a poor risk reward ratio

On Mar 12 06:35 AM alancelt wrote:

> I fully agree with this evaluation. The other thing that could hurt
> Amazon badly is sales tax. So far they have managed to escape paying
> sales tax in most states outside their base. With the recession biting,
> States will be looking at ways to boost their income and internet
> sales tax must be high on the list. Technically however the stock
> came out of an inverse head and shoulders formation so perhaps has
> an upside potential to around $85. If it gets there I would be going
> short again.

Mar 12 08:28 AM

[raytayzmd:]

...although expensive, a slowing economy actually favors Amazon relative to brick and mortar stores -- costs considerably less to manage a website ...also, online shopping is much easier and more convenient...tax issue -- unimportant...I live in Kentucky where I have to pay sales tax but nevertheless use Amazon for practically all my shopping needs because Amazon's prices still out compete local prices...online competition -- Amazon's sheer size no doubt gives it an edge over most retailers...and while Walmart might be able to compete on price, the difference is so marginal that there is little motivation to even make an effort to shop there...Ebay?...I'm willing to bet that if you surveyed the people who have purchased on Ebay, nine out of ten would report AT LEAST one unsatisfactory transaction...and I can tell you from personal experience that even if you are unhappy, Ebay will do nothing but provide lip service...finally, there is Kindle...Kindle, the death knell of print publishing...first went the newspapers, next goes all the rest...no more tree harvesting disrupting forest life; no more water and air polluting paper and ink manufacturing; no more eighteen wheel gas guzzling monuments to ecological disaster for delivery; no more warehouses measured in square miles for storage...hell, Amazon practically qualifies as a "green" stock...expensive -- yes, but worth it.

Mar 12 09:50 AM

[joes:]

Amazon has been the bane of short sellers since the late 90's, I knew a Pittsburgh firm that lost $25 million because they "knew" it had to go down.

The reality is that there is a chance that Amazon is the next Wal-Mart, so you can play around day to day and maybe make some money but your risk becoming a "great er fool".

Mar 12 12:07 PM

[Lightway:]

I've mentioned this on other articles, but you can't limit Amazon's business analysis or its competition to retailers. Amazon is also an IT shop, and sells its Internet infrastructure services to other firms. They have been a pioneer and best-practices leader with web based services, and so have already laid the groundwork and established mature processes, which other companies, mainly startups, can use to get their online business model up and running very quickly. Do some search on the (overhyped) "cloud" model, and it will bring up alot of the big name IT players, along with Amazon.

Mar 12 02:02 PM

[User 153407:]

I have read articles similar to this one on Amazon for 10 years. The bouyancy of their stock has defied analysis for a decade. It has always had "darling" status. This is one company no analyst has ever figured out. But the consumer has. Their prices are good, their service is impeccable, and they make good recommendations. It is as simple as that. Name another retailer that does all three...there are no others.

Mar 12 11:53 PM

[seattleite:]

LOL...Mark Mark Mark, This is the nth time I am telling you. Stop it dude. I dont have anything for or against Amazon. But I am surprised by how desperate you have become holding you shorts since the higher 40s. You have been writing almost one article per week saying that Amazon's evaluation is too high. I told you to cover long ago but you wont. I admire your risk taking though. Unfortunately you will have to cover higher.

Mar 21 05:55 AM