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Amazon (NASDAQ:AMZN) is a strong operating company and not a stock that is usually associated with undue hype or other “bubble-like” phenomena. However, just as Walmart (NYSE:WMT) and Duke Energy (NYSE:DUK) enjoyed sizeable run-ups during the dotcom bubble of the late 90s, Amazon is enjoying a considerable run-up due to the current cloud bubble.

Although Amazon is a strong company that is showing promise via its services and electronics diversification, I believe that the stock is extremely overvalued. My position is that Amazon is a retail stock that also dabbles in tech, NOT a technology company that also has a marketplace.

The Positives (Amazon as a company):

  • Annualized sales growth of 28.62% ($2.76B in 2000 to $34.2B in 2010)
  • Strong balance sheet (1.4 Current Ratio; $6.3B net cash; no debt)
  • Strong sales base via the Kindle
  • Growing services division

The Negatives (Amazon as a stock):

  • 22% equity dilution over the past 10 years (81M net shares issued)
  • No return to shareholders via dividends or share repurchases
  • Trading over 75 P/E of 2011 projections (based on $2.40 EPS)
  • Trading at a trailing P/S of 2.4 – P/B of 10.5
  • Sales tax loopholes rapidly closing
  • Strong competition in the tablet sector & in the web services sector


Amazon has performed very impressively over the past 10 years (mainly in terms of sales growth); however, this (and aggressive EPS estimates) is already heavily priced into its stock price. Amazon has been able to grow its online sales while its customers enjoy tax-free purchases. This loophole is rapidly closing, with California and Illinois creating the largest waves. Amazon realizes that losing the tax advantage will severely crippled its competitive advantage, and it is pledging $2.25M to fight the recent CA tax measure. Ironically, Amazon has agreed to comply with Senator Durbin’s newly proposed “Main Street Fairness Act,” but I believe that they are doing this because they know the tax will fail in the Republican house and they want to avoid a “tax dodger” reputation.

The Kindle is a widely selling device, but at current prices, does not provide significant margins; however, this is a nice “foot in the door” move to sell e-books. I believe that their tablet will fall flat similar to the HP Touch Pad. The technology (cloud hosting) division is promising; however, the total revenue contribution is insignificant compared to AMZN’s retail arm.

The Trade

Simple Short - If you buy into the AMZN “retailer trading like a tech growth” overvalued argument, I recommend either purchasing Jan 12 otm puts (recommend $160 at $13.90), or selling short with long call coverage for insurance (I recommend the $200 call at $11.50). If the long call is used with a 1-1 coverage, the breakeven point will be $166 AMZN on the downside end with a maximum loss of $3396 ($200 close exactly). If you have the stomach for naked shorting, you can also try that approach.

Spread Option - If you want to maximize your gains while limiting your potential losses to $2100 per spread, you can sell the $170 call while buying a $190 call and a $150 put ($100 net cost). This represents profitability below $149 and maximum loss at $190 or higher. $100 AMZN price nets roughly $5000 per spread.

Tax Law play - Short using the above technique and buy stock (or long calls- I prefer stock on this one though since the rough market might require a long time horizon) in Best Buy Co. (NYSE:BBY) and GameStop Corp. (NYSE:GME). I believe both stores will benefit largely from a shift in sales tax policy. I have already written articles that contain more valuation information on both Best Buy and Gamestop and more on Gamestop.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in AMZN over the next 72 hours. I closed my naked short on AMZN last week (basis of $210). I plan to buy puts within the next 72 hours.