Amazon: Fiction For Sale (AMZN)

By Ben McClure | May 02, 2007 AAA's (Nasdaq: AMZN) stock deserves a spot in its own online fiction-section.

Overexcited investors pushed up the online bookseller's price another 38% last week on the back of better-than-expected Q1 results.

Amazon has soared more than 60% since last summer, but it seems that the wild expectations built into the lofty stock price are too good to be true.

Consider that Amazon now trades on a whopping 63-times 2007 earnings. Google (Nasdaq: GOOG), by comparison, trades at 43-times and eBay (Nasdaq: EBAY) at 38-times.

To warrant this massive multiple, Amazon is going to have to deliver earnings growth that outstrips its internet peers. Yet, Wall Street analysts have all three stocks' earnings growth pegged at 20% to 25%.

No Longer a Start Up
The market still thinks of Amazon as a start-up with the promise of earnings power just around the corner. After all, Amazon's an internet stock that could have the same kind of earnings strength of Google and eBay; isn't it just matter of time before operating leverage and hefty profit margins kick in for Amazon?

Nope. The stock has been on the public markets for a decade and we've yet to see Amazon deliver much in the way of profitability. From what I can make out, Amazon's best earnings are probably behind it.

Sure, Amazon's revenue is expected to growing rapidly. The company is projecting 2007 sales in the range of $13.4 billion to $14 billion, an increase of 25% to 31%. That's mighty impressive.

Unimpressive Margins
However, look at the outlook for margins: Guidance shows that operating margins will remain not only flat, but also uninspiring at 4.8%. That's down from 6.8% in 2005. In other words, it's costing Amazon more and more for each additional dollar of sales.

Competition is sure to hold margins down. Remember, Amazon holds its own against (Nasdaq: OSTK) eBay, Wal-Mart (NYSE: WMT) and Best Buy (NYSE: BBY) by keeping its retail prices down and offering free shipping.

It also must keep dumping money into "whizzy' technology and marketing efforts, and all that spending comes at the expense of the bottom line.

Amazon is spending millions of dollars on web services that look like distractions.

As an example, take Amazon's Simple Storage Service, or S3, which charges 15 cents per gigabyte, per month, to store data on the company's servers. It seems miles away from Amazon's core retail business. Meanwhile, Amazon is renting out computing power for 10 cents an hour through Elastic Compute Cloud, or EC2. So far, the new ventures are only bringing in a trickle of revenue, and it's unclear whether they will ever be profitable.

Of course, there is hope that Amazon can become a major player in downloadable digital books, music and films. But, even if Amazon is successful in any of those areas, it will be several years before the results are material to a company with $12 billion worth of revenues. Revenues that come from selling stuff the old-fashioned way.

Amazon's earnings came in well ahead of Wall Street analysts' earnings forecasts. But in case you didn't notice, tax gains help explain how Amazon managed to beat the Street's consensus. As much as a third of its profits are from a surprisingly-low tax rate during the quarter. A weak U.S. dollar also gave Amazon earnings a lift.

Another thought: Amazon's balance sheet is nowhere near as pristine as its competitors. Amazon ended the quarter with $2.02 billion cash and marketable securities on the balance sheet and $1.22 billion long-term debt. Google and eBay have no debt whatsoever, suggesting that there are safer places to invest in the online universe.

Trading at a five-year high and on a far-fetched high-earnings multiple, Amazon makes for an unbelievable story. Investors should be prepared for an unhappy ending.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

comments powered by Disqus
Related Analysis
  1. Technical Look At eBay Inc
    Stock Analysis

    Technical Look At eBay Inc

  2. Priming the Pump for Q3 Earnings - Ahead of Wall Street
    Stock Analysis

    Priming the Pump for Q3 Earnings - Ahead of Wall Street

  3. India Remains An Emerging Market Bright Spot
    Stock Analysis

    India Remains An Emerging Market Bright Spot

  4. Jeff Bezos Versus Elon Musk: The Space Race,, Inc. & More
    Stock Analysis

    Jeff Bezos Versus Elon Musk: The Space Race,, Inc. & More

  5. Alt-Energy Up on Emerging Markets - Industry Outlook
    Stock Analysis

    Alt-Energy Up on Emerging Markets - Industry Outlook

Trading Center