A Great Company Propped Up By Wall Street's Latest Hype

| About: Amazon.com, Inc. (AMZN)

Summary

There is no doubt Amazon is a great company.

For a very long time, those who doubted its growth prospects have been proven wrong.

However, the company's share price has benefitted greatly from the move from active to passive.

A slowdown in the migration from active to passive or a reversal will cause its valuation to come down.

On the long side, I prefer to know why a stock is undervalued. I do not always succeed with coming up with a reason why it could be mispriced but I try. We all know the argument Amazon (NASDAQ:AMZN) is overvalued. All the metrics everyone knows point to it: 75x forward earnings, EV/EBITDA of 39x, P/B of 23x, etc.

But that's not a very convincing case for overvaluation is it? If everyone knows all these metrics why is Amazon still at $750+. The buyers aren't stupid. They make a rational decision to buy based on their assessment of future cash flows as well.

Or do they?

I'm sure everyone who buys Amazon stock directly understands the company extremely well. Many of you have foreseen the terrific future ahead of the company correctly and have been rewarded. Please note that to date all my articles on Amazon have been positive: the earliest one dating back to when Amazon was at $312.

I love the company and the way it's being run. I just happened to stumble into a chilling observation while researching something else.

To understand why this observation is so chilling you have to be aware of three things:

  1. The migration of actively managed funds towards passively managed funds (especially ETFs). 40% of U.S. fund assets are allocated towards passive ETFs, but actually the situation is worse.

  2. Investors like low beta ETFs with great historical returns, reasoning these are a better risk/reward.

  3. ETF sponsors construct ETFs by backtesting performance on risk/reward, and as a result, there is a virtuous cycle going where assets get allocated to low volatile stocks that are trending up and assets are departing funds of active managers who seek out fundamental value. We are in the longest period of growth stock dominance since WW II.

Now, back to how this all ties into Amazon's valuation.

Imagine you are adding an ETF to your portfolio. Perhaps after selling out of some mutual funds or hedge funds where even your rockstar management like Bruce Berkowitz or David Einhorn isn't delivering the returns you expected.

You know value as a strategy works, but momentum works as well. The value managers you had your money with didn't do so great lately so maybe it is wise to diversify between two investment styles that are both proven to work. You add the PowerShares S&P 500 Momentum Portfolio ETF (NYSEARCA:SPMO). However, value is really important to you, and you trust Morningstar's research, so the iShares Morningstar Large-Cap Value ETF (NYSEARCA:JKF) makes sense as well.

Finally, you finish up your portfolio with the AlphaClone Alternative Alpha ETF (NYSEARCA:ALFA).

A little bit of alternatives will go a long way to decrease the market risk, let alone single stock risk in your portfolio, right?

Well, it turns out you have just been buying big blocks of Amazon stock. The above have allocated 7.4%, 5.48% and 4.41% of their assets to Amazon. I picked those three on purpose because I don't think anyone would have guessed Amazon would even be in there with the exception of the momentum portfolio. In total, there are 83 ETFs that have Amazon as a top 10 holding. These are the top 25:

Ticker

ETF

ETFdb Category

Expense Ratio

Weighting

(NYSEARCA:RTH)

VanEck Vectors Retail ETF

Consumer Discretionary Equities

0.35%

15.13%

(NYSEARCA:XLY)

Consumer Discretionary Select Sector SPDR Fund

Consumer Discretionary Equities

0.15%

12.39%

(NYSEARCA:FDN)

First Trust Dow Jones Internet Index Fund

Technology Equities

0.57%

10.04%

(NYSEARCA:FDIS)

First Trust STOXX European Select Dividend Index Fund

Consumer Discretionary Equities

0.12%

9.95%

(NYSEARCA:VCR)

Vanguard Consumer Discretionary ETF

Consumer Discretionary Equities

0.12%

9.90%

(NYSEARCA:IYC)

iShares U.S. Consumer Services ETF

Consumer Discretionary Equities

0.43%

9.74%

(BATS:CNDF)

iShares Edge MSCI Multifactor Consumer Discretionary ETF

Consumer Discretionary Equities

0.35%

9.33%

(NASDAQ:PNQI)

PowerShares NASDAQ Internet Portfolio ETF

Technology Equities

0.60%

8.13%

(NYSEARCA:RXI)

iShares Global Consumer Discretionary ETF

Consumer Discretionary Equities

0.47%

7.63%

(SPMO)

PowerShares S&P 500 Momentum Portfolio ETF

Large Cap Growth Equities

0.25%

7.40%

(NASDAQ:QYLD)

Recon Capital NASDAQ 100 Covered Call ETF

Large Cap Blend Equities

0.60%

6.58%

(NASDAQ:QQQ)

PowerShares QQQ ETF

Large Cap Growth Equities

0.20%

6.57%

(NYSEARCA:SYG)

SPDR MFS Systematic Growth Equity ETF

Large Cap Growth Equities

0.60%

6.38%

(NYSEARCA:IGM)

iShares North American Tech ETF

Technology Equities

0.47%

6.37%

(NYSEARCA:ARKW)

Web X.0 ETF

Technology Equities

0.75%

5.84%

(NYSEARCA:JKE)

iShares Morningstar Large-Cap Value ETF

Large Cap Growth Equities

0.25%

5.48%

(NYSEARCA:JHMC)

John Hancock Multifactor Consumer Discretionary ETF

Large Cap Blend Equities

0.50%

5.24%

(NYSEARCA:MTUM)

iShares MSCI USA Momentum Factor ETF

All Cap Equities

0.15%

4.96%

(NYSEARCA:SYE)

SPDR MFS Systematic Core Equity ETF

Large Cap Blend Equities

0.60%

4.93%

(NASDAQ:ONEQ)

FIDELITY NASDAQ COMPOSITE INDEX ETF

All Cap Equities

0.30%

4.56%

(ALFA)

AlphaClone Alternative Alpha ETF

Hedge Fund

0.95%

4.41%

(NASDAQ:SKYY)

First Trust ISE Cloud Computing Index Fund

Technology Equities

0.60%

3.98%

(NYSEARCA:ARKK)

Ark Innovation ETF

Technology Equities

0.75%

3.97%

(NYSEARCA:ARKQ)

Industrial Innovation ETF

Industrials Equities

0.75%

3.83%

(NYSEARCA:IWY)

iShares Russell Top 200 Growth ETF

Large Cap Growth Equities

0.20%

3.73%

Click to enlarge

Table: 25 ETFs with the largest allocation % towards Amazon stock

Some of them make a lot of sense. Amazon should be in a retail or consumer ETF. Its presence with a ~10% allocation in a Consumer Services ETF is a little bit iffy, but that's not a big deal. However, Amazon back tests so well on risk/reward, it's apparently irresistible to include it in a strategy to build an ETF. It is in both value, momentum and growth strategy ETFs, it's in alternative strategies, it is in covered-call ETFs, it is in innovation ETFs and in Core Equity ETFs, it's in the S&P 500 ex-technology ETF (NYSEARCA:SPXT) and it's in the iShares North American Tech ETF, It's in the S&P 500 Fossil Fuel Free ETF (SPYX) and in the S&P 500 Catholic Value ETF (NASDAQ:CATH).

Could it be Amazon enjoyed a tailwind of funds shifting from active management to passive management?

I think the answer is yes. I've written positively on Amazon four times on Seeking Alpha, but today I'd rather short it than buy into this great company while its value is pushed up tremendously by the flow into passive investments. For now, I will patiently await better times to buy. A clear catalyst would be the reversal of flows active to passive.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.