Why I Wouldn't Buy Amazon

Amazon.com (AMZN) began as an internet book retailer and has expanded into sales of goods of all kinds. A consumer can now buy everything from groceries to the latest G-Unit CD on Amazon. Amazon's product offerings only continue to grow as they add more products to their site directly and invite outside sellers to sell through the Amazon portal. Amazon has even begun developing and selling its own products: the recently-introduced Kindle 2 created much buzz and will fluff Amazon's bottom line as they are the sole retailer of the high-margin product:

A teardown analysis of the Kindle 2 by market research firm iSuppli estimates the cost to build the device at $185.49, or about 52% of its retail price of $359. - (Businessweek)

With other offerings like apparel, foodstuffs, and mp3 downloads, Amazon is attempting to diversify into a seller that can supply almost anything a consumer could want. The strategy does seem to be working, as revenue and profit keep increasing despite a sour economy. However, Amazon's weakness has always been tight margins, and margin expansion is unlikely. The internet is an ultra-competitive animal, as many websites (like SlickDeals.net) exist solely to alert consumers to good deals. Amazon's decision to allow outside sellers to sell products on the website (via the Fulfillment-by-Amazon program and the simpler Selling on Amazon option) allows sellers to attempt to match or undercut Amazon's prices, making it more difficult for Amazon to retain healthy markups (except on niche products like the Kindle).

When Amazon can't increase margins, they increase volume, which has worked thus far. I believe it will continue to work, as consumers will increasingly turn to Amazon to meet all of their discretionary needs, so I do believe that Amazon will continue to be a growing, healthy, and increasingly profitable company.

However, Amazon makes the Do Not Buy List due to an overly-rich current valuation. Amazon is expected to make $1.50 per share this year, slapping a price to earnings ratio of over 50 on shares. Even next year's earnings, currently estimated at $1.94, will maintain a P/E of over 40. Since I believe that Amazon will continue to perform well, I'll say that Amazon will make $2.75/share next year - even with such results, the shares would still trade at a 29 P/E. These ratios are much, much higher than competitors, and seem unsustainable despite recent enthusiasm.

eBay (EBAY), Amazon's most comparable online competitor, trades at a P/E of just 10 (though that is partially attributable to problems with eBay's business). Wal-Mart (WMT), the diversified brick-and-mortar retailer, trades at a P/E of 15, while Target (TGT), Wal-Mart's smaller competitor, trades at a similar valuation. Best Buy (BBY), the electronics retailer, trades at roughly a 17 P/E.

Amazon's business model does differ from these retailers - Amazon is less of a pure-retail play with the addition of revenue streams like music sales, the Fulfillment by Amazon program, publishing, and more - but at its core, AMZN is a retailer. Amazon does have a world-class supply chain and does not have to pay for retail square footage like the aforementioned competitors do. But because a consumer can buy the same books, movies, and groceries from Target or Best Buy, Amazon's margins on such commoditized items will always remain slim.

The bottom line is that Amazon.com is a great company that trades at a somewhat-ridiculous valuation. AMZN will report earnings later this week, and I cannot believe that any news could propel shares much higher at this point. Therefore, Amazon will be placed on the Do Not Buy List for the short- to medium-term until margins show signs of improving, or earnings increase to a point where AMZN's P/E falls closer in line with competitors.

Comments

[logicalthought]

>>Amazon.com is a great company that trades at a somewhat-ridiculous valuation.<<

So what else is new? Even now, it looks technically way overextended. (Check out the V-shaped recovery on a weekly chart.) However, I have had way too many "expensive shorting experiences" with this company, so I have finally vowed to just ignore the stock, and instead spend that money (I'd lose shorting) buying stuff from them!

2009 Apr 23 06:44 AM

[raytayzmd]

...I agree with "logicalthought" -- same old arguments regarding "overvalued"...but Amazon keeps cutting deals and working on new revenue streams -- e.g. Tivo, game distribution, Kindle, "cloud computing"...what innovation has Walmart come up with recently?...Ebay???...... spends most of its time fixing mistakes its made...Amazon is expensive but long term it looks like a big winner.

2009 Apr 23 08:59 AM

[BerkeleyBob]

I suspect the rich valuation awarded Amazon is in part because it is sui generis. I think the analogy to EBAY, WalMart or BBY is weak. It is possible that earnings growth or net profit margins for AMZN will taper off or slow down but personally, I don't routinely fight the trend. If you don't like Amazon at present levels I guess you have a heart attack over the share price of Google. Disclosure, long AMZN, no position Google.

2009 Apr 23 11:16 AM

[Stephen Frankola]

Ray -
It's the Seeking Alpha editors that you can blame for that... not me.


On Apr 23 11:00 AM raytayzmd wrote:

> ...uhhh, are you simply redundant or desperate?...you posted the
> same thing under a different title just a little while ago:
>
> seekingalpha.com/artic...

2009 Apr 23 12:46 PM

[Lightway]

Again, make sure you're looking at their IT services reselling business when doing any sort of valuation analysis from the qualitative side. Amazon is one of the major players in the overhyped "cloud" IT market, reselling their IT infrastructure and services out to other companies. This lets small companies bring online IT services up quickly without investing in their own infrastructure. The cloud services are the hottest technology in the IT investment space, and although I personally believe the cloud does not warrant this much attention, industry analysts are giving any company with a lead in this area a major boost.

Amazon gets a tremendous amount of press coverage and financial analysis in this space, and you now have to mention them alongside other IT heavyweights such as Microsoft, not just brick and mortar shops like Wal-Mart or online sellers like Ebay. They have been online for nearly a decade now, and know how to create reliable and scalable online solutions, so they are already an industry leader in this space.

2009 Apr 23 02:26 PM

[Speedspirit]

What about the fact that the hurting newspapers are embracing Kindle. Whats next Magazines. Then there are more profits,eh.

2009 Apr 23 07:55 PM

[InvestBaboo]

Amazon's charts look solid. Near term target $100.

2009 Apr 24 02:00 AM

[j baker]

well, "seeking alpha" whaddya think now, I daytraded up $2500 yesterday and held 1k amzn shares overnight , only to walk out to my computer and see i was a little over 5k richer (on amazon) and about 1.5k richer on msft...

2009 Apr 24 04:33 PM

[subra ambati]

I don't understand how and why AMZN stock price keep going up and up since it hit 35 in November 2008. It simply does not make any sense. Last time, AMZN is at this level (87), DOW was at 14,000 and S&P was at 1500. Now, DOW is at 8000 and S&P is at 850 level (almost half) which implies that AMZN deserves to be at low 40s not high 80s. Comparing AMZN with its peers such as ebay (with P/E of 12) and with technologically superior companies such as GOOG, (also with a P/E of 20), not only the P/E of AMZN went to the roof (high 50s), but also its stock price more than doubled (almost trebled) to 87. AMZN is just an on-line retailer, does not have any barrier-to-entry for its products, anybody can start a business like AMZN's. Even a product better than KINDLE can be easily developed by a company such as Google which has thousands of Ph.D's unlike AMZN, and wipe out AMZN's Kindle revenues. As such, we heard in the last few weeks several companies developing Kindle like product for e-reading which can also be done on mobile devices such as iPHONE and blackberries. In addition, Kindle has a competitor SONY e-reader and newspaper publishers developing such device in near-term. By the end of this year, you will see a number of e-readers coming to the market before christmas. So, AMZN stock going up from 60 to 87 just based upon Kindle is ridiculous. Even other AMZN's businesses such as digital music, video downloads and cloud computing, there are a huge number of competitors. Even then, whenever any news about these topics comes out of AMZN, its stock price goes to the roof. Compared to the current economic condition and the consumer confidence, AMZN's stock price is way over-valued and must be SOLD.

2009 Apr 25 02:47 PM

[mysteryleo]

I would tend to agree with you.

www.traderbots.com/sto...

Our analysis is also pointing at a bearish trend for Amazon from a technical analysis point of view. Selling amzn is a good idea.

2009 May 03 08:02 AM