Amazon.com (AMZN) is an impressive company, which provides impressive online retail services for its customers. However, it is an absolutely terrible investment at current price levels. At $224 per share, Amazon trades at a 185 price-to-earnings multiple and a 1.97 price-to-sales ratio. Amazon has been an outlier based on its strikingly high valuations especially when compared with many attractively-priced traditional retailers.
Instead of flocking to Amazon, investors should find stocks that trade at reasonable valuations.
Internet Dreams and Retail Realities
Conceptually, I love internet retailing because it provides the opportunity to reduce capital expenditures and overhead. (This has NOT manifested for Amazon.com.) Moreover, it appears that the internet retailing movement conceived of more than a decade ago is now making casualties by killing brick-and-mortar stores and stealing their sales. Visibly, this is a real change in consumer behavior that should be scaring mall operators and landlords.
However, stock investors should not buy a stock because the company is disruptive or a game-changer. Instead, investors should buy stocks, which are trading lower than their intrinsic values. A poor company trading at a dismal price may be an excellent trade. Amazon's valuation is another extreme: a great stock trading at an overly enthusiastic valuation that should be avoided.
Furthermore, there seem to be limits to the electronic retailing trend. There are physical shopping needs that internet/delivery have not yet innovated:
Clothing: One size doesn't fit all. Worse yet, not all clothes in the same size will fit or look good on the same person. There is no mainstream technology that has been able to challenge a traditional dressing room experience. Attention hi-tech entrepreneurs: this is a big, disruptive technology opportunity to cut out the retail margins from the clothing industry. As it stands, the best an internet consumer can do is purchase multiple sizes and styles and then ship back the clothes that don't fit well.
Convenience: If I am running late I can't order a donut, batteries, or a pen from Amazon.com and receive the order in 30 minutes. Internet retailers for most goods might be able to extend the pizza delivery concept to other products. However, there is no threat to retailers on their pop-in customers.
Alcohol: Delivery alcohol is even less prevalent than drive-thru liquor stores.
Prescription Medication: People tend to fill and refill prescriptions in-person, and often cannot wait for a delivery time frame without severe repercussions.
Acceptable Investments in the Future of Retail
Investors should consider other retailers that are currently trading at understandable valuations. Near $60 per share, Wal-Mart (WMT) is trading at a low 13.09 price-to-earnings ratio and a low 0.45 price-to-sales ratio. Yes, Wal-Mart is hated. Yes, Mexican bribery allegations and the potential for damaging legal repercussions cloud the future of the stock. However, such things are not really what investing is about. Berkshire Hathaway didn't seem fazed by the news and it actually bought more WMT shares to its position in WMT during the last quarter. The value of an investment is the present value of the future cash flows, not how much you can boast about your holdings or how ashamed of them you may be.
Another brick-and-mortar name trading at compelling valuations is Walgreens (WAG). Near $33 per share, Walgreens is trading at a low 11.18 price-to-earnings ratio and a low 0.39 price-to-sales ratio. Investors may be weary of the loss of Walgreens customers to its rival, CVS Caremark (CVS). Will this matter in the long term? Sure, year-over-year revenue declines and the loss of Express Scripts as a partner are real, regrettable problems for shareholders. However, it is unlikely that the company will continue to falter in this way over, and over, and over again. Instead, it is a smart move to buy shares of this company while it is cheap, with the expectation that its performance will revert back to the industry mean.
Kohl's (KSS) is another familiar tenant of strip malls that trades at low valuations. Near $47 per share, Kohl's is trading at a low 10.89 price-to-earnings ratio and a low 0.60 price-to-sales ratio. As a brick-and-mortar, shoppers can use fitting rooms to determine what fits and what looks good.
The operating margins of these traditional brick-and-mortar competitors beat out Amazon:
Operating Margin (%)
Since lower margins for Amazon seem to be the norm, the only reason to buy a share of AMZN is the promise of future growth. How much growth would it take to justify a 185 price-to-earnings ratio when traditional retailers are trading near 11 times earnings? Using analyst estimates for earnings growth, we can determine how many years of projected growth it would take for the earnings of shares of Amazon, Wal-Mart, Kohl's, and Walgreens to converge so that their future price-to-earnings ratios are equal:
5-Year Growth Estimate
This graph clearly demonstrates Amazon's ridiculous valuation. Even assuming that long-term analyst growth rates will continue indefinitely (which is itself ridiculous) it would take over a decade of this phenomenal, uninterrupted earnings growth for Amazon's current valuation to be equivalent to that of Wal-Mart, Walgreens, or Kohl's.
Amazon is a great company that trades for an outlandish price. Wait for the valuations to drop before buying.