Why Amazon Is Overvalued

May. 1.09 | About: Amazon.com, Inc. (AMZN)

Business Description

From Amazon's (NASDAQ:AMZN) profile on Yahoo Finance:

Amazon.com, Inc. operates as an online retailer in North America and internationally.

Is It a Great Business?

A. Is it understandable? Yes. The website is very user friendly and I often make purchases from Amazon. However, I am not an expert on internet retailing.

B. Is management competent and honest? Jeff Bezos is very admirable; he built a company that not only has survived the dot com bubble bust, but also came out as a top online company.

C. Does Amazon have favorable long term prospects? Amazon has strong brand recognition that will probably be around for many years to come. What should be considered, however, is that the market for homes having internet is now saturated. So if near 90% of households in the U.S. have internet and access to Amazon.com, growth in sales and earnings can only come from increases in general consumer spending and or taking market share from big box competitors like Walmart or Target and the like, as well as internet competitors such as Ebay. With consumer spending trending down due to the current state of the economy, I do not see "favorable" long term prospects for Amazon at this point.

Is It a Great Price?

With 429 million shares outstanding and a share price of 79.79, the entire company cost about $34.23 billion. I ask myself this question: If I had $34.23 billion, would I want to buy this company or simply put my $34.23 billion in the bank?

To answer this question, I'll use the 5 AAA corporate bond rate to see what my earnings would be over the next 5 years versus what I think AMZN may be able to earn over the next 5 years based on average analysts estimates and compare the difference.

I also try to figure out what the potential future value might be for AMZN in 5 years time. In this case, I make my earnings estimate based on it being an ongoing business in 2013 and put AMZN up for sale at a Price to Earnings multiple of 10. I choose a P/E of 10 because AMZN may still be able to grow earnings at a rate of 10% in 2013, making the PEG 1.0.

Based on my calculations, AMZN may be able to earn $1.523 billion in net profit in the year 2013. This means that the company may be worth $15.23 billion or 35.23 per share, assuming 429 million shares are still outstanding in 2013.

But the key question is: If 35.23 is the value in 5 years, what is the present value and rate of return should I demand? I'm not an expert on internet retailing so I'll want a higher rate of return on my investment to offset my perceived additional risk. Personally, I'd want at least 7% more than my AAA bond return, so 10% per year. In that case, AMZN's fair present value today would be $21.88 per share. (See full article with worksheet here.)

Because AMZN is currently being offered by some of the shareholders for $79.79 per share as of April 29th, 2009, it is selling at a huge premium to what I believe to be a fair present value. At this price, AMZN does not seem to be selling at a great price, assuming the estimates don't get blown away, which I doubt will happen.

I also notice that with $34.23 billion, I would actually earn more in profit from a AAA rated corporate bond over the next 5 years Vs what Amazon is estimated to earn. This is a huge red flag and gives good reason to believe AMZN is way overvalued and acts as a good potential short at the current price.

Disclosure: Short Amazon for clients