Amazon: Great company, WAY overvalued stockSeptember 6, 2012: 3:40 PM ET
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.
I love Amazon.com. Fantastic customer service. Prices are great. And as an avid reader who still likes physical copies of books (call me a Luddite if you must), the free shipping that comes with being an Amazon Prime member is a nice bonus.
I also think it's admirable how Amazon has made many acquisitions and has let those sties run independently. Audible.com, Diapers.com and Zappos are just a few notable Amazon subsidiaries that have continued to flourish despite being owned by a much larger entity.
But my appreciation for Amazon as a company does not extend to Amazon's stock. Shares of Amazon (AMZN) now trade for more than 100 times 2013 earnings estimates. The stock is up more than 40% this year. It seems that investors are getting too caught up in the enthusiasm about Amazon's Kindle business and its small but growing cloud services division.
Sure, the new Kindle Fire tablets that Amazon is announced today could wind up being hot sellers for the company -- although how hot is a subject of debate since Amazon, unlike Apple (AAPL), steadfastly refuses to release any data about how many devices it actually sells. But shouldn't investors be more concerned about competition from Apple, which is expected to release a cheaper, smaller iPad later this fall?
And let's be honest. Amazon is still merely a retailer. It just happens to be one that is rooted in technology. We probably shouldn't be comparing it to the likes of mobile giants Apple and Google (GOOG) or cloud software leaders like Salesforce.com (CRM) in the first place. But for some good, clean fun, even Salesforce is "cheaper" than Amazon. It trades for only 75 times earnings estimates for its next fiscal year.
Of course, Amazon obviously deserves to trade at some sort of premium to other retailers, particularly ones that Amazon is seriously putting the squeeze on, such as Best Buy (BBY) and Barnes and Noble (BKS). Best Buy is valued at only 5 times fiscal 2013 earnings estimates while Barnes and Noble has no P/E because there is no E. The struggling book and Nook seller is expected to lose money this year and next.
But what about other healthy, mass market retailers? Wal-Mart (WMT) and Target (TGT) both trade at earnings multiples in the mid-teens based on earnings estimates for their next fiscal year. Does Amazon really deserve a P/E that's more than 7 times higher than these two?
Yes, Amazon is expected to continue growing at a much faster pace than Wal-Mart and Target. Analysts are forecasting earnings growth of about 33% a year, on average, for the next few years, while Wal-Mart's profits are predicted to rise just 8% and Target's earnings are estimated to grow 12% annually. Still, if you use these numbers to calculate what's known as a price-to-earnings growth or PEG ratio, a measure often used to justify higher valuations for momentum stocks, Amazon continues to look very frothy.
Amazon's PEG comes out to about 3.1. Target and Wal-Mart trade at PEGs of 1.1 and 1.7, respectively. Amazon is similarly overvalued if you look at the three on a price-to-sales ratio. Using Amazon's current market value of $113 billion and sales forecasts of $80.5 billion for 2013, Amazon's price-to-sales ratio is 1.4. The market values for Wal-Mart and Target are each about half of their expected sales.
I'd be more willing to accept the premise that Amazon should trade at a sky-high valuation if it was using its technological advantages to generate exorbitant profit margins. But it's not.
Amazon's net margins in the first half of 2012 were a puny 0.5% and operating margins were barely above 1%. To be fair, a lot of that is due to the company's strategy of investing heavily in new products and services. But Wal-Mart's net margins in the first six months of the year were 3.4%. Target's net margins were over 4%.
Don't get me wrong. I'm not suggesting that Amazon is a screaming short. What's more, the company has done a phenomenal job for nearly two decades. Jeff Bezos deserves a lot of credit for steering Amazon through the bursting of the dot-com bubble and two recessions. But that still doesn't mean Amazon deserves to trade at a triple-digit P/E.
Amazon may not be as much of a bubble as the stock was back in the late 1990s when an Internet analyst now more famous for being a journalist (he who shall not be named) famously slapped a $400 price target on the stock. But it might be getting close. Amazon has to prove to Wall Street soon that all its investments will one day lead to higher profit margins if it wants to remain this richly priced.