Why Shorting Amazon Is a Bad Idea

Watching the seven point surge in Amazon (AMZN) on Wednesday after the stock was upgraded, my first thought was that there must be quite a few shorts getting squeezed. Sure enough, over 6% of the float is borrowed, a huge amount for a large cap stock. My second was that this is a great example of how not to short a stock. Not because it went up, but rather because the only thesis for shorting Amazon is one of valuation. Betting against richly valued stocks is very seductive, because they are so easy to find (P/E of 60?!). It just makes sense that without crazy growth, the stock has to go down. Unless the stock also suffers from some of these deadly sins, however, the short is likely to end in tears.

Is the company engaged in fraud? Amazon isn't.

Is the company's balance sheet levered to the hilt? Amazon has almost no debt and tons of cash on hand.

Is the company's leadership incompetent? In Bezos, Amazon has one of the most respected CEOs working today.

Is the company in a dying industry, or one where technological change is rendering the company's competitive position untenable? Amazon is still growing, and the internet retail space is anything but dying. On top of that Amazon is the tech leader in the industry, as well as being the biggest.

In short, Amazon is a classic example of a very solid company trading at a high valuation. The stock may very well go down at some point, but as long as it keeps executing well buyers will look past valuation. Even assuming Amazon will eventually stumble, this could be years away giving it time to grow into the stock price. In the mean time the crowded short trade will get squeezed with every piece of good news that hits the tape.

And what a tape it is. Take a look at the past six months.

No doubt about it, the trend is up. Be careful out there.

Disclosure: No position in AMZN

Comments

[Eric Boughton_:]

Richard, I am short Amazon, and I fully respect your decision not to short Amazon. However, I will take issue with one of your basic points: "Betting against richly valued stocks is very seductive, because they are so easy to find..."

Richly valued large-cap stocks are absolutely not easy to find. Let me run a question by you: How many $3 bln mkt cap US-domiciled companies have both a PE above 30 (not a really high bar) and a price-to-book multiple above 3? Answer: 29. How many $30 bln mkt cap companies have both of these characteristics? Answer: precisely 2, namely Apple and Amazon.

Why does it matter that they are large-caps? For a short in richly-valued stocks to work, the law of large numbers must come into play before, in your words, the earnings have "time to grow into the stock price". Those, like me, who short ridiculously valued large-caps have the odds overwhelmingly stacked in our favor, because the odds of the company significantly increasing its earnings BEFORE the market assigns a fair DCF value to the stock are quite low.

And a return to fair value just creates your garden variety successful short; the real 'juice' happens when the company stumbles, like so many well-regarded companies eventually do.

Sep 18 01:13 PM

[Northstar10000:]

HOw about a September surprise from Isreal....
Lets see how many 7 point down days we can get from that little number. Stock will trade below 60 this year.

Sep 19 12:53 AM

[Richard Glenn:]

Eric, by "easy" I did not mean plentiful but rather that it does not take much digging to identify them. While you are certainly correct about the law of large numbers and mean reversion working in your favor in the long term, how long can you afford to wait, and how much pain can you take on the upside? The reason that I mentioned the fact that AMZN is a large cap is that big companies have access to resources that small companies don't. With an unlimited pool of capital, a short like AMZN very well might work out from these levels eventually, but I would guess that few shorts in the real world will be able to take the pain that may be necessary to get to the promised land. And that's assuming that AMZN does stumble. What if the kindle takes off, or cloud computing and AMZN hits it's growth wall five years from now after doubling it's earnings?

Oct 07 02:24 PM