Why Amazon Is Overvalued

Business Description

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

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

• Company Website
• SEC Filings

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

Comments

[Alan Young:]

A refreshingly level-headed approach to valuation. I'd agree that the stock is overpriced--perhaps not quite as much as you indicate, because it seems much less risky than other stocks with P/E 10.

However, although your analysis is valid, your investment tactics might not be, because you are assuming that the market will price the stock rationally. "Markets can stay irrational longer than most people can stay solvent." This short could produce a lot of pain.

May 01 03:47 AM

[TCK:]

Agree, mostly. However, AMZN has been over valued from the start. They were one of the many to report "Pro Forma Earnings". I don't know Latin, but loosely interpreted means, " earnings before bad things ".

Seems like investors have traded AMZN mostly on gross sales gains and the stock may remain over valued. Similar to the way other stocks are always " under valued " simply due the sector in which they reside.

May 01 09:11 AM

[raytayzmd:]

...oh, look, yet another post as to why AMZN is currently overvalued...and, like all the others, it basically rehashes the same arguments...unfortunat... those arguments MUST already be factored into the stock price since they've been posted several times a month for the past four months!!!...of course, in that time period, the stock has doubled -- but, hey, it's just money, right?...you would think the guy would've learned a lesson last year when he argued what a bargain Starbucks was at $17 a share...then I guess he just stood by in wonderment and disbelief as the market completely ignored him and sent SBUX down to $7 over the next six months...hoo, boy, I bet his clients were sweating that one!...personally, with large cap stocks I always presume the market has already absorbed and factored in pertinent financial data...and I never presume to tell the market what it SHOULD do given that information...with the large caps, I say ride the trend and maintain a trailing stop loss...as they say, "the trend is your friend."

May 01 09:21 AM

[Jakeg:]

You've got to remember that Amazon is more than just a retail business. They have a cloud computing division that stands to generate huge revenue in the coming years along with Kindle, and Amazon Fresh.

May 01 09:41 AM

[Jason Tillberg:]

I never bougtht Starbucks, even when it got to 7. Don't trust long term prospects. From my article on Starbucks however, I indicated two points: 1. "It is in my opinion that many of the earnings forecasts of corporations are too high and are not factoring in these "recessionary times." " and 2. "The best part about the "adjustment" in share prices we're seeing is that over the coming quarters and years, many great companies may very well become great values."

Just how low will Starbucks go before it bottoms is anyone's guess." $7 was pretty darn low.

Remember, stock valuations are a voting machine in the short term and a weighing machine in the long term. MSFT and EBAY both have P/E's now of 10 and 12 respectively. No reason why AMZN can't see a share price in the future with a P/E of 10 down the road.

Investors buy for income, speculators buy in the "hope" of selling at a higher price soon after.

Traders will "speculate" the share price will go to $100 in the short term. Good luck with that.

On May 01 09:21 AM raytayzmd wrote:

> ...oh, look, yet another post as to why AMZN is currently overvalued...and,
> like all the others, it basically rehashes the same arguments...unfortunat...
> those arguments MUST already be factored into the stock price since
> they've been posted several times a month for the past four months!!!...of
> course, in that time period, the stock has doubled -- but, hey, it's
> just money, right?...you would think the guy would've learned a lesson
> last year when he argued what a bargain Starbucks was at $17 a share...then
> I guess he just stood by in wonderment and disbelief as the market
> completely ignored him and sent SBUX down to $7 over the next six
> months...hoo, boy, I bet his clients were sweating that one!...personally,
> with large cap stocks I always presume the market has already absorbed
> and factored in pertinent financial data...and I never presume to
> tell the market what it SHOULD do given that information...with the
> large caps, I say ride the trend and maintain a trailing stop loss...as
> they say, "the trend is your friend."

May 01 09:42 AM

[Jason Tillberg:]

They better have something more than just retailing over the internet, how else could they grow earnings 21% per year for the next 5 years? It's a high estimate and they will need to be creative to achieve that kind of earnings growth.


On May 01 09:41 AM Jakeg wrote:

> You've got to remember that Amazon is more than just a retail business.
> They have a cloud computing division that stands to generate huge
> revenue in the coming years along with Kindle, and Amazon Fresh.

May 01 09:45 AM

[bozak:]

The same old faulty arguments about why Amazon is overvalued that have been batted around for about 2 years now. You are correct that internet growth is saturated in the US, but you have ignored other avenues of growth for Amazon. International business, the Kindle, and cloud computing all have a lot of room for growth. Additionally, the domestic business is not just tied to "internet access" it is tied to consumer spending habits. Although these habits are trending down in aggregate, Amazon continues to get a bigger piece of the pie. This trend will likely continue for a long time. The bottom line is that Amazon has a legit chance of becoming the world's largest retailer in the next ten years through superior customer service and the best logistical controls on the planet. Then through in some high margin businesses like the Kindle, movie rentals, and computing services and the current market cap starts to look like a bargain.

May 01 09:47 AM

[Jakeg:]

Agreed. Merrill Lynch is expecting the market to reach a ballpark figure of $160 billion by 2011. It seems that Amazon is well positioned to capture quite a bit of the cloud market but who knows.

May 01 09:49 AM

[LoveShorting:]

Jason, thanks, whether you are right or wrong, your logical arguments make me feel better about being among the few to be shorting that clown Bezos. Even if I lose a little more $ before an inevtiable pullback.

May 01 10:20 AM

[InvestBaboo:]

The charts don' t think Amazon is overvalued. They show a possible run by Amazon to 100 plus in the near future. There is a lot of "blah blah" I can do taking both the bull and the bear side but at the end of the day the charts rule and they say Amazon is a buy and that it will run up higher to 100 plus.

May 02 03:06 AM

[mdtrader:]

At close to $80 a share, an investor would need 20% compound EPS growth for the next 5 years, in order to normalise the PEG to 1. Even if the company achieved such monumental growth, the stock would still be trading on 21 times earnings, 5 years out. If you look back at the previous 5 year period, Amazon did in fact achieve 20% compound EPS growth, but it did so starting from $5 billion revenues, with very favourable economic conditions. Today the same level of growth is expected but starting from $20 billion in revenues, not to mention that economic conditions and internet saturation levels are clearly less favourable.

Wall Street may love Amazon at $80, but one day they will wake up and find the stock trading at sub $40. Great company, but the valuation is way too high for me.

May 02 04:05 AM

[boisterousbob:]

Well, people comment that the internet is "saturated" I assume they mean everyone has access. I am not sure though, that you can make a leap that just because people have the internet at home that internet shopping is saturated. That's a bit like saying car sales are saturated because we built the highways.

I have bought many things on the internet including a car. However I do not shop at amazon because I find their prices excessively expensive.

However I find their marketplace, and kindle to be fascinating business concepts. The marketplace is like being a mall operator, and I could easily see how that business could grow into the same size as amazon itself in time. Further, with the kindle will amazon do to books what apple did to music delivery?

Amazon is overpriced based upon its current shape and size, sure. And this article expresses it rationally. But, just an opinion, short it long term at your peril.

May 03 03:22 AM

[Cool Beans:]

Well I covered my AMZN short along with all my other short positions two weeks ago. There's something about this stock market rally that makes me terrified to have any positions at all, long or short. It seems way overdone but it has shown such resilience that I think is better to wait before shorting anything, overvalued or not. 1st quarter earnings were not as bad as expected for the most part and I really don't see any catalyst in the near term which would cause stocks to plunge.

Obviously nobody cares about the "stress test"

WFC rallying 22% in a day because Warren Buffet gave a motivational speech? The same day it's announced they'll need to raise $10 billion in equity? Something funny is going on here and I'd rather not participate at the moment. I sure am glad I covered all my shorts so far......

May 04 09:10 PM