Amazon.com (NASDAQ: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 (NASDAQ: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 (NYSE:WMT), the diversified brick-and-mortar retailer, trades at a P/E of 15, while Target (NYSE:TGT), Wal-Mart's smaller competitor, trades at a similar valuation. Best Buy (NYSE: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.