Short Amazon: Risky Investment at Current Price

Oct.27.09 | About:, Inc. (AMZN)

In May, I wrote an article claiming that AMZN was overvalued. It was at that time, 79.79 per share. In the short term, I could not have been more wrong.

We know that share prices of companies are like voting machines in the short term and weighing machines in the long run. The enthusiasm about Amazon today is quite positive and voters are certainly signaling they want to own Amazon, at any price.

Yesterday, AMZN closed at 124.64 per share.

I'm going to upgrade AMZN from my last report in May. I had lower expectations of revenue growth. The recent quarter, they showed quite impressive revenue growth of 28% over last year's revenue in the 3rd Quarter. Very impressive to say the least. I hate to think the millions now unemployed who are home, collecting unemployment checks, are simply buying more stuff and not saving in the event they can't get a job when their unemployment runs out.

In my last report, I put AMZN at having a "fair" present value of 21.88 per share. I have recalculated a fair present value at 56.50 per share. I still remain bearish on the current price however and would recommend a short for non risk adverse investors.

First and foremost, the tech boom is over. Saturation of the market of households with internet access is near complete. Throughout the late 90's and for most of the 2000's, E-Commerce enjoyed fantastic year over year gains in sales as a higher and higher % of households began to have internet access, thus giving them access to companies that sold things over the internet.

The Federal Reserve provides us with the data on E-Commerce sales to better demonstrate the great sales gains in the early part of the 2000's.

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Great stuff, until the market got saturated with homes having internet. In February of 2009, Nielson reported: More than 80% of Americans now have a computer in their homes, and of those, almost 92% have internet access, according to a detailed study on home internet access from The Nielsen Company, which reports that this number is up from 77.9% one year earlier.

I don't know exactly what the peak of homes having internet access will be, but we're nearly there I believe.

The bottom line is, the big growth that was seen in the 1990's and early to mid 2000's in E-Commerce sales is over. In order for Internet retailers to now grow their revenues, they must either steal market share from their competitors, gain sales from brick and mortar, or gain more customers. Let the competitions begin! I love this quote from this article here. "The Wal-Mart (NYSE:WMT) CEO recently commented 'If there is going to be a 'Wal-Mart of the Web' it is going to be'" The E-commerce sales war will be interesting and margin tightening I can only imagine. (Capitialists who engineer the best distribution win. There is nothing wrong whatsoever with that. The men and women behind these businesses deserve to be rich.)

So what about Amazon's valuation today? Frankly, it's crazy in my opinion. Utterly overvalued. The expectations of 26% annual earnings growth over the next 5 years is asking for a lot in this environment. I do have a bias. For one, I'm currently short AMZN shares. Second, I do think we are headed for a "greater depression."

Let's take a look at my Stock Market Value Investing Analysis Worksheet below.

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To start, a 5 year AAA rated bond will earn you more in income than AMZN is expected to earn in the next 5 years. That right off the bat begs the question, why take a risk in AMZN not meeting earnings expectations and simply taking the money you would use to buy shares of AMZN and park in a safe AAA Corp. bond?

I know that Amazon will not be liquidating itself in 5 years, so this is not a "cigar butt" type of investment. Amazon will be around for years to come. But in 5 years, at what price? What will Amazon be worth in 5 years I ask myself? I'll take the analyst estimate of earnings growth and assume that in 5 years, Amazon will earn $2.644 billion in 2014. In 2014, 5 years from now, I think AMZN will command a P/E multiple of 15, because I think AMZN can grow earnings 15% per year and I want to see the PEG ratio of 1.0. I think AMZN is worth about $24.4 billion in 5 years.

If I discount that at 10.21% (7% more than the 3.21% from a AAA Corp. Bond) per year or what I would demand for such a risky investment, I come up with a present value of $56.50 per share today. Much lower than the current price of $124.64, and this is after I've upgraded them. I've also given them the benefit of the doubt they can grow earnings 26% per year for the next 5 years. That 28% revenue growth this recent quarter really was impressive.

Amazon remains a highly risky investment at the current price. Due to the current price, I will remain short for both myself and the very few (luckily) clients who are short AMZN.

Disclosure: Putting money where my mouth is, short AMZN for self and few clients (2).