Now, don't get me wrong - I like Amazon (AMZN) as a business. I think that it has many good deals from many reputable sellers. I use it occasionally when I need something that isn't readily available at a neighborhood store. However, I think that the stock is extremely risky due to its overvaluation.
Early in 2011, Amazon stock began to grow faster than earnings, as shown in the 5 year Ycharts.com chart. We typically like to see forward PE ratios under 15, PEG ratios under 1, and price to book ratios under 3 for an undervaluation. However, Amazon has a forward PE ratio of 88.19, a PEG of 6.32, and a price to book ratio of 14.2. This shows a blatant overvaluation.
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The problem with overvalued stocks is that they are very sensitive to negative news which can cause large drops in stock price. On the bright side, Amazon also has large increases in stock price on positive news. Over the past year, the stock had price swings of 18% - 30% in both directions. The recent 21% surge in stock price was a result of the Q1 earnings beat. This surge places the stock close to its 2011 peak in an overbought condition.
The stock looks to be more of a trading vehicle in the short-term rather than as an investment. The chart shows many well-defined conditions of overbought and oversold stock prices that swing drastically in both directions.
Now that the excitement of the Q1 2012 report is over, I think that the stock will drop at least 10%, perhaps more. The trading strategy is to do a calendar Put spread that should benefit from decaying premium. Initially, buy the July $220 put and sell the May $220 put. This will cost about $705 for one contract ($1080 - $375). When May expiration passes on May 18, we would then sell the June $220 put or another Put that is out of the money. Then, if the stock didn't reach the oversold level by the June expiration, we would sell an out of the money July put. By repeatedly selling the puts on a monthly basis, we're reducing the total cost, since we collect the premium that is sold. I would exit the position when the oversold level is reached.
This is for experienced options traders only who agree with my thesis. Option trading is not for everyone.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
