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Tickers in this Article: AMZN, EBAY, GOOG, WMT, OSTK
On the back of record-breaking holiday sales, over-excited investors pushed Amazon's (Nasdaq:AMZN) stock price up 60% from its low point in November. Unfortunately, the new hope that's built in to the online retailer's stock price is probably too good to be true. Overvalued?
Consider that Amazon now trades on a whopping 38-times forward earnings. Google (Nasdaq:GOOG), by comparison, trades at 15-times and eBay (Nasdaq:EBAY) at less than nine-times.


To warrant this massive multiple, Amazon is going to have to deliver earnings growth that outstrips its internet peers. Yet Wall Street analyst estimates suggest that Amazon's 2008 earnings growth, pegged at about 23%, will be no better than Google's.

The market still seems to think of Amazon as a start-up with the promise of big earnings growth just around the corner. After all, Amazon is an internet stock that could have the same kind of earnings power as Google, right? Isn't it just a matter of time before operating leverage and hefty profit margins kick-in at Amazon? Don't count on it. Amazon has been on the public market since 1997 and we've yet to see the company deliver much in the way of profitability. Moreover, from what I can make out, Amazon's peak profitability is behind it.

Sure, Amazon's top line growth is very impressive. Back in October, Amazon projected full-year 2008 net sales of between $18.46 billion and $19.46 billion, or to grow between 24% and 31% compared with 2007.

However, look at the company's profitability. Its operating margin was just 3.6% last quarter, down from 5.7% in 2007. Amazon's latest set of guidance pegs full-year profit margins at 3.8-4.5%. As time goes on, it's costing Amazon more to produce each new dollar of sales.

Competition is sure to keep earnings down. Remember, Amazon must hold its own against Internet players like eBay and Overstock (Nasdaq:OSTK) - including online brick-and-mortar groups like Walmart (NYSE:WMT) - by lowering its retail prices and offering free shipping. What's more, in the face of a global economic slowdown, online retail growth could be in for tough times ahead.

Bottom Line
Cutting back on technology and content development is probably the easiest way for Amazon to increase profits. Last quarter, the company capitalized $41 million, or about 35% of net income, in costs associated with internal-use software and website development. Cutting back on these items could hurt revenue growth, prompting investors to regard Amazon as something less than a high-flier stock.


Until Amazon can figure out a better way to boost profitability and earnings over the next year or so, investors are probably safer staying clear of the stock. (For further reading, see Introduction To Fundamental Analysis.)

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