iPad Pricing Will Burn Amazon

Includes: AAPL, AMZN, NFLX
by: Ry Frank

Amazon (NASDAQ:AMZN), which is well-known as an online marketplace and media download center, has been selling its Kindle Fire at $199 (a loss reportedly), presumably in a bid to encourage buyers spend on its ever-growing bank of videos, music, books and periodicals. The company employs a similar strategy to encourage consumers to buy their media from its company by undercutting the competition. For instance, if you want to rent a "new release" movie, it will cost $3.99 on Amazon compared to Apple (NASDAQ:AAPL) iTunes' $4.99.

Amazon's Kindle is number two in tablets, falling behind Apple's iPad. According to market research firm IHS Apple's share of the tablet market is 57% versus the Kindle Fire's 14%. The difference is large but keep in mind that the Kindle has only been around for a few months, making its rise nothing short of meteoric. Amazon has even been starting to get into the original content market - like Netflix (NASDAQ:NFLX) has and Hulu.

But, now Amazon seems to have backed itself into a corner.

When Apple introduced its new iPad on March 7, it also announced that it would continue offering its 16GB iPad 2, dropping the price of the Wi-Fi only version to $399. Given that the iPad has a much larger screen (9.7" versus Kindle Fire's 7"), Amazon is will have a much more difficult time justifying its $199 price tag.

Considering that Amazon is already selling the Kindle Fire at a loss - and its media at a discount - it is essentially stuck. If it lowers the price further, it would be adding to the sieve and would risk alienating that section of customers that bought a Kindle because they couldn't afford or justify a larger tablet, like an iPad. The company could introduce a larger screen or new features, but it would have to keep the value high - perhaps even keeping the price steady. Otherwise, it could marginalize the difference between its Kindle Fire and its more expensive competitors, like the iPad.

Amazon recently traded at $184 a share. Analysts expect, on average, that the stock will reach over $217 in the next year. If they are right, investors buying in now would enjoy a one year return of over 18%, but I have my doubts.

I think that Amazon is best avoided right now. The company finished the fourth quarter 2011 with a net income of $177 million; in comparison, its net income fell from $416 million at the end of the same quarter last year. Amazon also had reductions in its return on equity, falling below its industry's average as well as the market at large, and its quick ratio leaves something to be desired, coming in at just 0.79.

Amazon's stock performance is just as bad. The company has returned 10.71% over the last 52 weeks, compared to the market's 9.95% for the same period. While it is trading at a premium, the difference is slight. Amazon is actually moving on a downward trend. It is trading less than its 50-day moving average, which is less than its 200-day moving average. Plus, Amazon is priced high at 69.39 times its forward earnings.

I am sure this company will eventually bounce back. I think that its lower priced Kindles will sell like mad this Spring. They have that unique glare-free screen that makes reading in sunlight easier than on a traditional tablet, are inexpensive (less than $100) and are easy to handle - making them perfect for reading outdoors. But, I also think that it will be hit hard by the new iPad pricing, so I am recommending investors avoid this stock until we can see how the new iPad affects things.

Besides, there are other companies in the tablet market that I like better - like Apple.

Apple is very strong right now. The company, which recently traded for just over $568 a share, has returned over 60% over the last 52 weeks and there is still room for this stock to run. Analysts say that Apple's share price could go as high as $730 a share in the next year, representing a return of over 28.5% - if they are correct. It has high revenue growth, rising earnings per share and a strong quick ratio of 1.35. Given that its return on equity is also high, well outperforming its industry. Apple is also priced low, with a forward price to earnings ratio of 11.89.

I think Apple has a really bright future. Not only are its customers some of the most loyal in the world, but its products are setting the pace for technology today. Apple's user-friendly, intuitive GUI (graphic user interface) is being actively imitated by companies across the board. The company is also paving the way through its iCloud. Amazon may offer cloud services but Apple blends it across devices, taking interconnectivity to a whole new level. This way, if you add a contact or take a picture on your iPhone, for instance, it automatically appears on your iMac and your iPad. Additionally, Apple has a reputation for quality and speed - pluses in anyone's book.

I think that Apple will be able to maintain and grow its market share in the tablet market. Its iPad is easy to use. It has tons of apps, a good reputation, an easy-to-use interface and a good size. Now that the price is lower, I think things will begin to heat up soon - maybe even enough to burn the Kindle Fire.

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