A River of Doubt

While the NASDAQ fell nearly 2% today, shares of Amazon continue to levitate in the stratosphere. The question for investors is how likely is this to continue?

The company’s SEC filings make the case for caution.

At the end of today’s trading, Amazon closed at $220.07, giving it a P/E ratio of 181.73 (source:  Yahoo Finance).   A P/E above 50 – at least in the ancient days before the dot.com bubble and QEs 1 through 75 – used to signify either 1) a company on the cusp of explosive growth; or 2) a beaten-down cyclical on the verge of an upswing.

Amazon, however, fits neither of these categories.  Instead, the market appears  to be confusing high growth in revenues with growth in profits, which is another story entirely.

Consider the following chart (data from SEC Edgar for AMZN and WMT):

From 2007-09, Amazon had similar net margins to Walmart even though Walmart’s operating margins were higher.

However, in the last two fiscal years, Amazon’s margins have fallen off the cliff.  Yahoo Finance reports a trailing 12 month profit margin of a mere 1.09%, and AMZN’s latest 10Q states a net margin of only 0.99%.

This trend is likely to be exacerbated by state efforts to force Amazon to collect sales taxes (which begins in Texas starting July 1, 2012).

Now, let’s assume that Amazon could get its margins back up to Walmart levels.  What would that do to Amazon’s P/E ratio?

Consider the following chart for the effect on AMZN’s earnings:

This looks impressive, but Walmart trades at a PE of 14.69 (as of 6/25/12).

Let’s look at a few other numbers:

According to Yahoo Finance (which closely matches the numbers calculated from Amazon’s 10K and 10Q filings), AMZN’s trailing twelve month (TTM) diluted EPS is $1.21 per share.

Using Walmart’s TTM net margin of 3.52% would give Amazon a diluted EPS of $4.02 per share.

If Amazon had achieved this, AMZN’s P/E today would be a mere 54.7 (and compare to Apple’s P/E of 13.91).

On the other hand, if the market began to value AMZN according to its profitability, and not its revenue growth (in other words, like Walmart), the stock could be priced as follows:

Assume Amazon with Walmart margins and a Walmart P/E ($4.02 * 14.69) = $59.05

Assume Amazon with AMZN margins and a Walmart P/E ($1.21 * 14.69) = $17.77.

In other words, AMZN appears to resemble the coyote in the old roadrunner cartoons.  Wiley E has run off the cliff, but keeps running in levitation for a while before he finally looks down and plummets.

As always, though, the question is timing.

Disclosure:  I am short Amazon via puts.

Also note:  this is a discussion forum, and is not an offer of investment advice.  This is merely one data point, so do not take a position in AMZN without doing your own research first!

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3 Responses to “A River of Doubt”

  1. Singapore t-shirt printing Says:

    Howdy! This blog post couldn’t be written any better!
    Going through this post reminds me of my previous roommate!
    He continually kept preaching about this. I most certainly will send this post to him.
    Pretty sure he will have a very good read. I appreciate you for sharing!

  2. And the Winner is… Wait, What? Says:

    […] political/financial blogger with a grossly outdated WordPress theme (the original one, I think) claimed over a year ago that Amazon stock was way overpriced. So, naturally, since that time, Amazon stock has gone… up? Maybe it’s that […]

  3. Amazon Revisited | No Money No Worries Says:

    […] Roughly a year ago, we examined whether shares of Amazon could continue to levitate in the face of the company’s minuscule profitability.  See A River of Doubt – June 25, 2012. […]

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