When it comes to this market, there are plenty of things that make you shake your head. One stock I love discussing and analyzing is Amazon (AMZN). Amazon is one of the most intriguing names out there because it just does things differently. That sometimes makes a company hard to figure out, and it can lead to a broad spectrum of opinions. Now I can't say any opinion is really wrong, because different investors and analysts use different measures. Some think Amazon will go higher because the company is constantly looking to increase sales. Others argue that the company will eventually fall because it is not making money.
In the past, I have not been shy about calling an Amazon a short because of the earnings issue. You can go back and look at my Amazon articles to see that. But today, I want to look at Amazon in a different light. Today, I'm not going to play the bear, I'm going to play the bull. I will show you how using one particular valuation metric shows that Amazon could have tremendous upside left. I've made a similar argument in the past, but not to this extent.
Since Amazon is primarily a retailer, I am going to use the price to sales metric to prove my point. So first, I am going to show you Amazon's trailing twelve month sales numbers, going all the way back to the end of 2007. As you can see in the chart below, Amazon's trailing sales figure has constantly grown. From 2008 to 2011 Amazon's yearly sales rose from $19.2 billion to $48.1 billion.
It's been a great rise for Amazon's sales, and the stock hasn't done too bad either. The following chart, taken from Yahoo! Finance, shows Amazon's stock over the past five years. If you bought Amazon five years ago, you would have spent $92.59 per share. On Monday, Amazon closed at $254.80. That's a return of over 175% over five years, compared to 42.5% in the PowerShares QQQ ETF (QQQ), the Nasdaq-100 ETF in which Amazon is the 6th largest holding.
As sales have risen, so has the stock. Now, you may come back at me and say, so what, earnings have gone down, margins are questionable, and a million other things. But you know what? The trailing twelve month earnings number for Amazon has dropped in every quarter since Q4 of 2010. The average share price during that quarter was about $170. The average share price so far this quarter is over $238. Do earnings matter? Amazon's stock would tell you no.
So that's why I am focusing on the price to sales ratio. Here's where things get interesting. The table below shows the following data: the average closing price in shares during that quarter (actual average price), as well as the average number of diluted shares (in millions), plus the corresponding average market cap during the quarter (in millions), and the trailing twelve month sales figure (in millions) that includes that quarter. So for instance, in Q1 of 2008, Amazon's trailing 12-month sales (including 3 quarters from 2007) were nearly $16 billion. The average daily market cap was $31.85 billion, so the average price to sales ratio for the quarter was 2.00.
So here are the average quarterly price to sales numbers:
- Past four quarters: 1.92.
- Past eight quarters: 2.03.
- Past twelve quarters: 2.03.
- Past sixteen quarters: 1.90.
- Past eighteen quarters: 1.91.
So basically, Amazon has traded at roughly 1.9 to 2.0 times the trailing twelve month sales figures, on average. Now, I've also done an average for the current quarter, Q3 of 2012. The average closing price so far this quarter is $238.10, and using a constant of 458 million shares outstanding, the average price to sales figure is 1.90, about the same as the overall averages. That also assumes Amazon has $13.92 billion in revenues this quarter, the current analyst average estimate.
So let's look at where Amazon could go from here. The following table shows where Amazon shares could go based on what revenues end up being for the year. Now, the current analyst average estimate for Amazon revenues in 2012 is $62.8 billion, so I would be really surprised if Amazon did not come within the range below. The top line shows revenues, and the left side provides price to sales values.
Now remember, the prices above would be a average daily closing price for the quarter, based on how I calculated the data above. So for instance, if Apple did $62.5 billion in revenues, and you give them a price to sales value of 2.0, you would expect the average closing price for Q4 of this year to be about $273. Now that is the average daily price, so Amazon shares would trade for more and less than that price throughout the quarter.
Now since 2012 is about 75% over, let's look forward to next year. The current analyst average for 2013 revenues for Amazon is $80.73 billion. So I've provided a similar table below.
So here's where you can get into some debate. The average price to sales ratio in recent years has been 1.9 to 2.0. Let's say that you don't like how Amazon can't turn a profit, or that sales growth is coming down. So let's only give them a 1.8 price to sales valuation next year. Even at that value, and assuming they come in a little light on revenues at $80 billion, you still have an average closing price in Q4 of 2013 of $314.41. That's at 1.8 times. Give them a 2.0 times valuation, and you could be looking at $350.
If Amazon continues to trade alongside its sales growth, there is plenty of upside in this stock. Now, do you think that price to sales value is too high, or too low? I think that the 1.9 to 2.0 range is pretty fair, considering Amazon has traded between the 1.7 and 2.3 range since things normalized after the financial crisis.
But it also depends on what you consider Amazon to be. Is it a growth retailer, a growth technology company, or perhaps both? To think about that question, just look at the following table. The table shows the current and next fiscal year revenue growth for each name, along with the price to sales ratio, trailing twelve months, based on Monday's close. To analyze the question, I've compared Amazon against two growth tech names, Apple (AAPL) and Google (GOOG), along with two retailers, Wal-Mart (WMT) and Best Buy (BBY).
*non-GAAP estimate, including impact of Motorola Mobility acquisition.
As you can see, Amazon is basically in the middle. It doesn't have the high price to sales of a growth technology company, but it also doesn't have the low value of a retailer. That's because many see the name as a hybrid, and that is why Amazon is so unique. Even the analysts believe this name goes higher, with the average price target at $272 and some as high as $400.
There are also many people that question what will happen to Amazon once it starts collecting sales tax in certain states. Well, initially, it does actually provide a boost to Amazon's sales, as people buy as much as they can before the tax goes into place. For instance, I read an article about a couple in California buying $10,000 worth of appliances on Amazon the week before Amazon was set to start collecting sales tax in that state. They will still buy from Amazon, but they made some big purchases before the sales tax rule went into effect. Do you think people will stop buying from Amazon? Not if it maintains a pricing advantage over other names, plus the convenience of shipping it to you for free. Plus, there will be a pre-tax boost as people try to buy as much as possible with no taxes.
When you look at the price to sales ratio, Amazon could have plenty of upside remaining. Even if you decide to take down the P/S value by a tenth or two, for whatever issue you want, Amazon could still return 20% or more over the next year or so. Give it a higher valuation, and $350 could even be possible. I'm long Amazon currently, but only for a trade, and I'll probably be in and out of Amazon multiple times over the next year. But one thing is certain. I, like many, questioned Amazon a year ago saying the rally would never last. It has, and then some, and for now, if things continue, Amazon shares will only go higher.
Disclosure: I am long AMZN.
Additional disclosure: Author long AMZN at time of writing, but does trade in and out of certain names, including some mentioned in this article, throughout the year.