What To Do With Our Amazon Short Now?

We noted in our post on 7/12/06 that we were short Amazon (AMZN). This position has been a big winner for us, but the question is where we go from here? We analyzed the stock today in our discounted cash flow model [DCF]. Given the company’s lower guidance on operating earnings for 2007, we have lowered our assumptions about EBITDA margins. On that basis, we can see the stock having downside potential to 25 or less.

One way to understand the stock being down 7 points today is to understand that given the company’s lower guidance, we estimate that ten cents per share in projected earnings for 2006 may be lost. Given that the company traded for about 40X earnings for 2007, if a 40 multiple is put on ten cents that equates to a reduction in price of $4.00, which is in the range of how much the stock has been down today. But even if we amend our earnings estimate to $.75 for fiscal 2007, the stock is still trading for over 30x that number. As we have said in our previous post, that is a rich valuation.

If we were to place a 20x multiple on an estimate of fiscal 2007 earnings of $.75, that would imply a price target of $15.00. Our DCF analysis projects a higher price for Amazon than does our PE analysis. Why? As we stated on the 7/12/06 post, when the market gets "nervous", it "believes" less in future cash flows. Cash flows are what drive the DCF model. When the market gets "nervous" it relies more on what "is" the case in the present, that being earnings in the near future.

Though there may be a short-term bounce from here, we think further price deterioration in Amazon is a real possibility.

AMZN 1-yr chart:

The views of Philip Frank, PhD of Insight Asset Management LLC are based on information Insight Asset Management LLC believes to be, but can not guarantee to be, accurate. Our views are not intended to be a forecast or guarantee of future events, or investment advice. There can be no assurance that securities we mention will remain in our investment portfolios