show me the money

jeff bezos amazon amzn stock
Sponsored By:

AMZN – Amazon Stock Valuation Reflects Unrealistic Expectations

Amazon (AMZN) is one of those stocks that proves the bears wrong at every turn. So it’s worth admitting right out of the gate that AMZN and CEO Jeff Bezos have a great track record of success in the face of skepticism.

amzn amazon stock logoThat said, the valuation skeptics may have a point about AMZN stock.

The problem with Amazon stock isn’t as simple as the fact that the company is trading for a nosebleed price-to-earnings ratio. (“Nosebleed” is the highly scientific term for a stock with a forward P/E of 145 … isn’t it?). After all, Amazon has historically traded for a pretty big premium to future earnings — much in the same way that Apple (AAPL) has historically traded at a relatively low premium to earnings compared with its peers and the market broadly.

The bigger issue for AMZN stock investors is the fact that that Amazon’s big earnings multiple is a reflection of tremendous expectations for this tech giant …

Expectations that even Jeff Bezos & Co. will have a tough time living up to.

What’s in Store for Amazon Stock

Amazon made a big splash on TV and in social media a few weeks back when it unveiled its Amazon Prime Air — an idea to enlist AMZN drones to deliver packages to sites nearby the company’s fulfillment centers for quick and cost-effective delivery.

AMZN stock also is getting some buzz from the rather unsexy grocery segment. According to USA Today, Amazon could be taking on discounters like Costco (COST) and Sams Club (SAM) by offering paper towels, cereal and other packaged goods for prompt delivery and at reduced price if you’re a member of the exclusive Amazon Prime club.

Oh yeah, and about Amazon Prime: Some research pegs membership at roughly 17 million AMZN users. At $79 annually, that’s a cool $1.4 billion in cash from its membership dues alone.

All that is impressive, and will push Amazon revenue to $75 billion this year — more than double its revenue recorded in 2010, and triple AMZN revenue recorded in 2009.

That kind of amazing growth is clearly worth something.

But … Where Are AMZN Profits?

Of course, despite this growth in sales comes despite Amazon stock not posting a penny of profit in fiscal 2012. Instead, the company invested heavily in future growth — including capital expenditures to build data centers and warehousing infrastructure around the world.

Still,  in the last year, shares are up 55% on the expectations that this big growth will pay off.

It’s a logical assumption. Amazon needed to subsidize its Kindle tablets to keep prices low and snag market share from the Apple iPad and devices powered by Google (GOOG) and its Android software. Amazon also needed to invest big in data centers to keep up with the roaring traffic demands as it welcomes more than 80 million visitors each month in the U.S. alone. And then there’s the need for fulfillment centers to keep shipping times low and to store all that stuff those 80 million people are buying.

Once AMZN is built out, it’s off to the races… right?

Maybe. But maybe not.

But a lot of those expenses smack of maintaining the business — not growing it.

Amazon needs to subsidize the Kindle so it can keep sales of books and movies flowing to those devices instead of losing out to iTunes or to Google Play when it comes to content sales.

Amazon also needs to keep its edge on price and shipping to keep its loyal customers happy, and to win new ones. Part of the reason its revenue is so high is because of the expectation it has created for both low prices and quick shipping.

Furthermore, capital expenditures show no sign of slowing down. In 2012 the company spent about $3.8 billion on capex, and is pacing about the same number — perhaps even more — for 2013.

Expectations Matter

So how does any of this AMZN spending actually improve margins instead of simply maintaining the current model?

For now, it doesn’t.

That means that the last year or so have all been in anticipation of these all-elusive profits at some point.

It’s fun to speculate about the potential of drones because of how utterly science fiction the idea is. It’s also fun to compare Amazon’s recent in-house programming efforts like its Alpha House series with Netflix (NFLX) originals including House of Cards.

But investing isn’t about fun and games. It’s about profit.

While Amazon should be admired for its discipline and commitment to the future even at the cost of present profits, investors need to be wary of letting unrealistic expectations take hold.

Because all it will take is a setback or two and AMZN may tumble from its loft expectations — much in the way other innovators have once investors learn to separate hype from reality.

I’d never bet against Amazon, and shorting this stock has been a fool’s errand for a long time — with AMZN soaring 650% in the last five years and 55% YTD in 2013.

But I simply don’t trust this stock at these levels. There are too many assumptions, too little profit and too much that can go wrong over the next few years to disrupt the the pie-in-the-sky narrative.

More on AMZN

Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not own a position in any of the stocks named here. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP

Get The Slant delivered to your inbox every day!

Comments