Is Amazon A $500 Stock?

| About:, Inc. (AMZN)

In many verticals, it's tough to separate the winners from the losers. Tesla (NASDAQ:TSLA), for example, comes out of nowhere to shock the staid, boring auto industry. At this point, I can't tell you with confidence how the drama will play out. Tesla has first mover advantage and the lead in innovation, while Toyota (NYSE:TM), Ford (NYSE:F), GM (NYSE:GM) and Chrysler have distribution, scale and resource advantages. It'll be fun to watch - from the sidelines. If I could figure out (with near certainty) what the auto industry will look like in five years, maybe I would make a bet in the sector. But I can't, so I won't.

On the other hand, I know what online retail will look like in five years. Amazon (NASDAQ:AMZN) will be the dominant number one player, with not even a close second. It's one reason why I made Amazon the first pick for my Top Ten list for 2013 - a list which is up 46% (so far) - and if I were to do a Top Ten list for 2014, it would be my first pick again. (Go here if you'd like to review the record.)

One reason I can say with confidence that Amazon will be the dominant Internet retailer in five years (and ten, fifteen, twenty): They've got scale. Here's what I mean by scale: Amazon will sell about $180 billion in merchandise next year, more than the next 15 online competitors combined. Because of their size, they have an enormous cost advantage. A moat like none other. There is nothing quite like scale in a market where efficiency determines the winner.

Physical retailers like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) can make all the noise they want about competing with Amazon, but the game is already over. Sure, physical retailers can carve out a bit of online space for themselves, but to be a real player? Not going to happen.

How do I know? It's called markup. Amazon charges a 12.5% markup, a level only Costco (NASDAQ:COST) can match. The next closest: Wal-Mart, at 34%. Target is 42%. Most retailers are over 50%. Because of their cost structure, physical retailers will NEVER be able to compete with Amazon on price.

Funny thing is, I've seen columns over the last few months, baloney that retailers such as Bed, Bath & Beyond (their average markup is wow, 82%!), are competitive on pricing v. Amazon, and how many items were, in fact, priced below Amazon. Now you know the truth. A 12.5% markup. Only Costco is in their league.

A word as to Amazon profits, which many observers say are miniscule. The truth: Amazon generates plenty of profit, but because they are aggressively building out distribution to handle $400-500 billion in sales, expenses that really should offset 2015 or 2016 revenue are offsetting current revenue.

This will give you an idea of their earning power: Of the $138 billion worth of goods and services that will be sold in 2013, over 50% are from third-party sales, which will generate commissions of nearly $10 billion. Amazon could drop commissions to the bottom line (there is no cost of goods sold on commissions) if it chose to, but it doesn't. Other companies exaggerate earnings, to get a better stock price. Amazon is the opposite. (The reason why should be obvious to you.)

Increasing 2014 price target to $500

Last year I posted an Amazon price target of $325 to $350 for 2013, $425 to $475 for 2014. I'm bumping my target to $500 for 2014, on the underappreciated value of Amazon Web Services (which is worth $50 billion by itself).

When you think about the Amazon model, think platform, toll bridge, ecosystem. Think about the end game, too - which is same day, free delivery. Shipping costs Amazon 2.7% of GMV (gross merchandise value of sales). To see that as a permanent burden is misguided. Amazon tacked on 7-9% in sales tax in various states and witnessed continued strong growth. The takeaway should make Amazon bulls salivate: Amazon has untapped pricing power.

Disclosure: I am long AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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