Forward P/E Distortions: Amazon.com

| About: Amazon.com, Inc. (AMZN)

Pursuant to a previous article, here is another example of another stock with a distorted P/E ratio listing, Amazon (AMZN). Though one should not compare apples with oranges, as there are major differences between Atheros (NASDAQ:ATHR) and Amazon, both have fallen victim to the Forward P/E Distortion Syndrome.

The current quarter for both AMZN and ATHR ends in March 2007. Trailing twelve months (ttm) PE conventionally refers to the last reported period, going back 12 months. This is the earnings for 2006. Forward PE conventionally refers to the following 12 months. This is the earnings for 2007.

Many computer programs have a ‘bug’ in them. In a nut shell, because we are now in 2007, programs erroneously take 2008 as the following 12 months. In most cases, 2008 figures are analyst estimates without the foundation of company guidance. More often than not, these figures change substantially, both up and down, over the pursuing six months. For some reason once the first quarter of 2007 is reported the programs correct themselves and calculate forward PE correctly; meaning Q2 2007 through Q1 2008.

Take a look at the Yahoo! Finance figures here and here.

You will notice the following:

1) Current year average EPS estimates (2007) are at 0.67. This is what ‘Forward PE’ should be calculated on.
2) Next year EPS is 0.92. 2008 is not a true basis for forward PE as 24 months out is inherently unreliable.
3) Under the “Delayed quote data” heading you have ttm EPS listed as 0.45 and a ttm PE of 86.43. This is not a typo, this is correct. Amazon is trading at a PE of over 80!
4) Yahoo! Finance lists the Forward P/E (1yr) as 42.09! This is incorrect. As mentioned above, the computer program has taken the closing price of 38.72 and divided by the 2008 figure of 0.92 resulting in a forward PE of 42.09. The correct calculation should be; 38.72 divided by 0.67 = 57.8.

Summary: The current price of an Amazon share is at 86 times ttm earnings and at 57 times forward 1 year projected earnings and at 42 times the earnings guestimate in two years from now.

Apples, Oranges and Peaches
Another way of looking at this is that due to the forward PE being artificially lowered as a result of incorrect information, the market may not realize that it is pricing ATHR and AMZN too high based on what would have been reasonable expectations, at least in the case for ATHR.

In the case of ATHR, both revenue and profit will increase in line with guidance. Yes, that means in line with 2007 guidance – NOT 2008 (there is no official guidance for 2008). Unless ATHR has a blow-out quarter in Q1 2007, this stock will crash when it reports earnings for Q1. Then we get stuck in a ‘once burnt twice cautious’ mode and when the stock should eventually appreciate in value, it lags.

Just last year the same happened to Syneron Medical (NASDAQ:ELOS). In Q4 2005 the market got ahead of itself and priced ELOS in the 40’s – peachy indeed! When the stock obviously couldn’t meet those types of expectations, the market punished the stock for 6 months all the way down to 18. Finally the stock rebounded to a normal range of around 26. Now it can grow in a normal fashion.

We have to wait for the execution of Q1 to determine if ATHR should be trading above 24. In fact it shouldn’t be above 23 right now. Currently the market has assigned a value as if ATHR already reported EPS at 0.25 for Q1 2007. This is unlikely to happen for several reasons – not within the scope of this article. We like ATHR, and are long term long on this company. [Disclosure: some associates own ATHR based on our research.] Logically, why should ATHR get ‘punished’ and have the stock drop to 16 or lower, in consequence of some misconception or other market shenanigans? At current multiples (ttm 75!), the slightest hiccup will send this stock down 50%. ATHR has some (manufacturing) hurdles to get over. At more reasonable multiples, time to recover is granted without panic setting in.

In the case of AMZN, the forward P/E distortion is compounded with unreasonable analyst expectations for 2007. The company’s own guidance says so! Be it suffice to say that as much as we like the concept around the hype – or is that the hype around the concept – AMZN is beginning to show its true colors a-propos being a money making machine. IT CAN’T DO IT.

Why do you think JB poured hundreds of millions of your Dollars into exploring other income avenues? Maybe if his initials were JC he could pull it off (referring to Jim Cramer, is there any other godly possibility?). God has just done a ‘coin-flip’ again and is now negative on tech. G-d help us!

Notice the severe change in attitude at AMZN when high margin items are in jeopardy.

Right now AMZN has reached the point of diminishing returns. In plain English this means that in order to feed the market expectations, at least in revenue growth, it has to take on lower margin items. While maintaining 25% revenue growth, profit margins continue to decline. Eventually the company will start posting losses (again) and that is when we start the downsizing cycle or as some say ‘back to basics’. In contrast with ATHR, we have a long term bearish outlook on AMZN.

Fool’s Platter

The Motley Fool recently published an article that basically said the same thing but from a slightly different angle. Below is an excerpt.

Legg Mason chief investment strategist Michael Mauboussin talks a lot about expectations. His ideas show me that there aren't "cheap" or "expensive" stocks. Instead, there are three types of stocks:

1. Stocks that meet the market's expectations.
2. Stocks that fall short of the market's expectations.
3. Stocks that exceed the market's expectations.

Suffice to say that we'd all like to fill our portfolios with stocks that exceed the expectations the market has priced into them…
Thus, it can be much more advantageous to hold Company A, which grows earnings 5%, instead of Company B, which grows earnings 25%, if the market expected 3% growth from Company A and 30% growth from Company B. Heck, the biggest stock price bumps occur when results are better than the market expected …
Consider these examples:
Company.....................................Three-Year Revenue Growth*............Three-Year Return
Micron Technology (NYSE: MU)..........15.7%........................................................(18.9%)
Amazon.com (NASDAQ: AMZN)..........26.7%.......................................................(14.7%)
Novellus Systems (NASDAQ: NVLS)......21.5%.......................................................(5.5%)
Denny's (NASDAQ: DENN)..................2.7%........................................................599%
Carolina Group (NYSE: CG).................3.7%........................................................156%
*Annualized. Data courtesy of Capital IQ

Why did impressive earnings growth translate into mediocre stock-price growth for Micron, Amazon, and Novellus? One answer, of course, is expectations. The market expected more from these companies than they could achieve. It clearly didn't expect quite as much from Denny's or Carolina Group -- and these stocks have simply blown away the market's expectations.

Conclusion
Be careful and do your own calculations for forward PE during the first quarter of every calendar year.

There is a major difference between a forward PE of 22 and 32. Atheros (ATHR) should be trading at a forward PE of 30 which is $24.00 per share. That’s because we are bullish on this stock, otherwise $21.00/$23.00 is reasonable. Remember, the current forward PE is not 22. A ‘run’ now on ATHR is to its intermediate term and perhaps long-term detriment.

Amazon (AMZN), adopting the bullish stance for the moment, should be trading around $28.15/$30.15, or between 42 to 45 times forward earnings. The most bullish analyst estimate puts 2007 earnings at 0.78. At 0.78 times 45, assuming a bullish growth rate as well, this gives a current value of $35.10. In our honest opinion, last year lows will eventually be taken out but only after AMZN reports for Q2 2007, demonstrating that there is no-way that this company will ever pluck $1B in a given year for the next five years. There is even a chance that AMZN can’t do it accumulatively. We couldn’t care less about a run on AMZN other than maybe shorting at 39+…the stock is headed south over the long term anyway so if it crashes it will just get there sooner.

All stocks that ‘run’ end up with a crash. There has never been an exception. When a company lends its treasury stock to a brokerage house to cover shorts, the run is for the company’s stock compensation program and brokers – not the investors. After the two have cashed-in, the stock crashes. This is the flip-side of the Overstock (NASDAQ:OSTK) case. Naked shorts drive down the stock price. Covered shorts drive the price up. Nowadays investors do not write letters to the SEC. Instead, shareholders have found that class action is far more rewarding. We trust ATHR is not lending any stock.

Now compare the ttm + forward PE, projected revenue growth and earnings growth for AMZN, ATHR and ELOS and admit you like fruit cocktail! By the end of this week we should know which of the three is the choice produce for thee.

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