I want to ignore Amazon’s (NASDAQ:AMZN) third quarter results for a moment. I want to step back and reflect on the question of valuation. Amazon’s valuation makes no sense whatsoever.
1. Until the blowup that will take future EPS estimates down, the stock was trading at a forward PE of 71x. Trailing PE was 100.
2. Before the earnings miss, the 5 year projected EPS growth rate was around 20%-25%. The PEG was over 4.0. Good value is considered to be 1.0.
3. The EV/EBITDA was an absurd 56x. Good value for a stock like with these growth characteristics would be in the high single digits.
4. The ROE was around 15% Given the projected growth rate, this would support a P/BV of 4.0 at the most. AMZN’s P/BV was 13.9!
Depending on what happens in Europe, the US equity market is on the verge of entering into what could be brutal bear market. Bear markets have no tolerance for valuations like this.
At a price of $100 Amazon would still be ridiculously expensive by any reasonable standard.
A Few Observations
Amazon is buying sales growth at the expense of profitability. That is clear from the latest quarterly report. That might not be as big of a problem if the company were trying to break into a new market with prospects for future profitability. The problem is that to some extent, AMZN is running in place.
The margins that they are earning on Kindle clearly indicate that Amazon is not interested in profitability in that segment. Amazon is interested in boosting sales in their existing business.
But boosting sales of digital books and other products, to some extent cannibalizes their existing business of selling paper books. Thus, the payoff to rapid sales growth may not be as great as it appears on the surface.
Selling a bunch of Kindles at break-even and selling digital books that cut into your sales of paper books is a business plan that might make sense as an adjustment to new technological realities and as a defensive maneuver to fend off new-comers in the book sale business. It might even improve the overall margins of your book selling business for a while -- until other folks start intruding into this commoditized space.
The problem is that the valuation that people are paying for AMZN is for a company that is going to multiply its earnings by a factor of five or more very soon.
This business plan is not going to cut it.
Amazon is a great company. Its stock price is not going to zero -- as that of Netflix (NASDAQ:NFLX) could. It’s just that AMZN is not worth anywhere near its current price.
I believe that AMZN could trade down below $100, sooner than many might expect.
Hope dies hard with a darling stock like this. Therefore, it probably will not be too late short this stock tomorrow.
Until this earnings miss, valuations did not matter for AMZN. After this earnings miss, and particularly in a bear market environment, valuation will matter a great deal.
That is not good for folks that have been speculating in AMZN stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.