By Larry Gellar
Amazon.com (NASDAQ:AMZN) is up big on the day of this writing, and it simply amazes me how much people can overvalue this stock. Of course, the reason why Amazon is up so much is an admittedly terrific earnings report, so first I will detail what made that so great.
Most importantly, Amazon beat analyst expectations for earnings per share by six cents and revenue by over $250 million. I can see why that would get people excited, and the results are made even better by the fact that Amazon's own Kindle Fire is its top-selling product.
Even outside sources like comScore are claiming that the Kindle Fire has over half of the market for Google's (NASDAQ:GOOG) Android tablets. (On the other hand, the market for Apple (NASDAQ:AAPL) iPads dwarfs the market for Android tablets, but we will discuss that later). Although many analysts have questioned whether Amazon actually makes any profit from the Kindle Fire directly, strong sales of the Kindle Fire are still important, since it often leads to other purchases from Amazon.
In fact, those strong sales of the Kindle Fire helped Amazon's North American media sales tremendously, with the segment seeing an increase of 17%. That was important for Amazon because the quarter before was a bit underwhelming due to poorer than expected video game sales. As for the next quarter, Amazon is expecting total revenue to be between $11.9 billion and $13.3 billion, which would represent growth of 20% to 34%.
Another peripheral issue surrounding the earnings report was that Amazon's net income actually declined year-over-year, but the company chalked that up to the various investments it's making. For instance, chief financial officer Tom Szkutak mentioned that significant investments were made in Web services infrastructure, video content rights, and fulfillment centers.
I'm not questioning the strength of Amazon's earnings report, but I do think investors need to take a good hard look at how wildly Amazon is being valued right now. Amazon has a price to earnings ratio of 187.46, a price to book ratio of 11.5, and a price to sales ratio of 1.84. For comparison's sake, note that eBay (NASDAQ:EBAY) has a price to earnings ratio of 16.2, price to book ratio of 2.95, and price to sales ratio of 4.55. PC Mall (MALL) has a price to earnings ratio of 25.65, price to book ratio of 0.67, and price to sales ratio of 0.05.
Now obviously, eBay and PC Mall are different than Amazon in very significant ways. My point, though, is that Amazon would have to be absolutely destroying these companies to justify its current valuation. Amazon's price to earnings ratio alone looks more like a like company that's just starting out and barely has profitability because it's so new. Amazon is too old for that type of valuation. At its heart, the company is an online retailer, and in my opinion, there is simply too much competition in that field to be buying a stock with a price to earnings ratio of nearly 200.
I also think it's worth pointing out that while Amazon does have significantly better margins (1.34% net profit, 22.44% gross, 4.18% EBITD, 1.79% operating) than PC Mall, eBay in turn has significantly better margins than Amazon.
If I were going to invest in a stock with ratios like Amazon's, it would have to be perfect. As the earnings release Q&A shows, though, Amazon does have some problems it needs to watch out for. As CFO Thomas Szkutak discussed in his answer to one question, the recent Thailand floods are the type of event that can throw Amazon off. Amazon was fortunate enough to be able to rely on third-party vendors that still had inventory, but that may not always happen. In my opinion, disasters can affect any company negatively, which is why it's important not to overpay for the stock.
There are a couple of other factors that could possibly derail Amazon. While I would not consider Amazon to be overly sensitive to Europe, the fact remains that an economic downturn there would certainly hurt this extremely global company. In my opinion, there are significantly cheaper stocks out there that have less exposure to Europe.
Another interesting problem is the tax issues that are starting to crop up. The trend appears to be for U.S. states and other entities to start demanding Amazon charge sales tax, and I can't really imagine this going away. When budgets are crunched, states will continue to ask why Amazon should be exempt from sales tax. After all, purchases are purchases even if they're from an online vendor. Again, this will affect other companies too, but they almost invariably have cheaper stocks.
One last thing about Amazon's earnings report I'd like to point out is that much of Amazon's beat can be attributed to equity-method investments. This was initially brought up by Business Insider (and also mentioned by TheStreet), and it's a terrific point. Without income from companies like Living Social, Amazon would still have beat analyst expectations, but by a significant smaller margin. These investments don't represent organic growth on the part of Amazon and could be extremely volatile going forward. For the type of valuation that Amazon is seeing right now, I'd like to see more of the profit come from Amazon itself.
Due to large amounts of changes in working capital, Amazon actually had negative operating cash flow for the first quarter. Those are obviously growing pains and are completely understandable. On the other hand, I just don't see the type of astronomical growth that would be required to justify the stock's price ratios. Like I mentioned before, this company would either have to be perfect or in its infant stages for me to buy at these ratios. I don't really see either of those to be the case, so I have to recommend investors stay away for now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.