The Case Against (and For) Amazon's (AMZN) Valuation

Joel Anderson  |

It wouldn’t really be fair to call Amazon (AMZN) a battleground stock as there’s isn’t all that much debate over the company, and what debate there is is hardly that heated. Which is pretty strange for a company with a P/E ratio north of 1,200.

Despite consistently failing to make any real money, Amazon continues to attract mostly positive reviews. Its short float is just 1.87 percent (which has to be some sort of record for the biggest spread between P/E ratio and short float. What’s more, on October 25, after the company reported earnings (another loss, by the way), no fewer than six different analysts reiterated their buy rating with a price target at $400 a share or better (okay, so technically RBC Capital Markets terms it “outperform”). And that’s not counting the Telsey Advisory Group which doesn’t issue a rating, per se, but did increase its price target for the company to a whopping $460 a share. Three days later, Deutsche Bank (DB) chimed in with another reiteration of a buy rating, popping its price target from $335 a share to, you guessed it, $400 a share.

But not everyone is totally on board. Standpoint Research made a pretty bold statement on the same day as Deutsche Bank made their upgrade with a sell rating and a price target of $280 a share. More than just a contrarian, Standpoint may be standing up for those old-school investors out there, kneeling before their pictures of Warren Buffett, clutching their copies of Ben Graham’s Security Analysis, and screaming profanely about how it's beyond them that anyone can think a company with no profits can be worth more than $150 billion.

So, here’s a quick look at why some out there see Amazon as an emperor with no clothes, and why they might be wrong.

The Bears’ Case

No Profits is NOT a Good Business Model. No, Really, I Read it in a Book Somewhere.

I mean, it’s not hard to see where most people think Amazon’s got things backwards. Reported earnings for the most recently reported quarter were…not earnings. The company suffered a $41 million loss, good for $0.09 a share. And for all the belief in Amazon’s business plan, the future of online retail, and where the company’s going, why would one invest in a company that’s not profitable. From the shareholder’s perspective, it’s hard to see what the benefit is. The company’s not headed for a dividend any time soon, nor is a share buyback coming. And how much higher could the stock possibly go?

It Can’t POSSIBLY Be Worth it at That Price

Which segues nicely into the second point from the bears. It’s worth asking. How much higher COULD Amazon go? Clearly most analysts think the answer to that’s another $50 a share, give or take, but are they right? Or is it possible that the future earnings have already been MORE than priced into the current share price?

The current P/E ratio of over 1,200 (based on the trailing twelve month, six of which Amazon was profitable for) would mean that the company’s earnings would need to be about 80 times higher before the company’s share price would be in line with the price folks are paying for Wal-Mart’s (WMT) earnings. A company that, not incidentally, offers a dividend yield of almost 2.5 percent.

So even if the bulls are right and everything in Amazon’s future is sunshine and flower, it would still need to be a LOT of sunshine and flowers before owning Amazon’s shares would make sense.

Not a Novel Idea Anymore

And Wal-Mart is an interesting company to consider in all this. Amazon’s sales figures have the markets quite excited. In 2012, the company had sales of $63 billion. Oooh, that’s great. Really. But Wal-Mart had $444 billion, seven times higher.

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Which brings us to a final point: we don’t all think Wal-Mart is just going to sit around and LET online retail destroy it, do we? Wal-Mart has an infrastructure and brand recognition that Amazon would kill for. Sure, Amazon might be blazing a trail to a world where people do all their shopping online, but isn’t Wal-Mart really in a better position to rule over that world than Amazon? The cautionary tale of Blockbuster Video becoming obsolete in the face of Netflix (NFLX) is a powerful one, but we don’t honestly think Wal-Mart is Blockbuster, do we?

Moving forward, it’s probably not out of the question to expect a lot more competition for online retail. And the Wal-Marts of the world, not to mention most of the more moribund retailers out there, are probably going to start flexing their own muscle in this segment in a whole new way long before Amazon’s reached the levels it seems to be shooting for.

The Bulls’ Case

We Don’t NEED Profits, Grandpa!

The idea that Amazon NEEDS to be turning a profit at this point is, to those investors putting up all this cash, quaint, quite frankly. The fact is, Amazon could be turning a profit, it’s just opting not to, instead reinvesting profits into expansion. A $41 million loss this last quarter isn’t the end of the world for Jeff Bezos and company. Not by any stretch of the imagination.

For starters, with $4.65 billion in cash on hand, they could only withstand losses like that for, oh, another 115 straight quarters before things start to get really dire (just shy of 30 years, in case you’re keeping track). More important to the people ready to pay $350 a share for Amazon, revenue and sales just keep going up. Year over year, operating cash flow was up 48 percent in Q3 of 2013. For sales, that was a 24 percent jump in the same period.

The money that’s NOT going into earnings is going to ensuring that sales keep going up that fast. So, when one invests in Amazon, you’re paying for growth, not earnings.

Total Global Domination is Expensive. Just Ask the British Empire.

And for the true visionary, Amazon’s grasp on the future of retail is why you’re more than happy to keep forgoing any real earnings. Amazon is planning big things. REALLY big things. The sort of things that require reinvestment. Namely, the company appears to be the Wal-Mart of the new millennium. And while Wal-Mart may have something to say about this before all’s said and done (as is noted above), that doesn’t mean Amazon’s any less aggressive in pursuing world domination.

The company’s Q3 earnings report showed that it had 109,800 employees, meaning it had passed Microsoft (MSFT) for the first time. It also means that the company hired 12,800 people in just the last three months. Where are they all going to work? Oh, how about the massive, utopian city-like campus Amazon’s constructing outside Seattle at a cost of $1.4 billion over the last year. Amazon’s still basically giving away its Kindle tablets, roping in more and more Amazon Prime subscribers, and building out their infrastructure to improve margins.

Simply put, it’s not just that Amazon’s reinvesting profits, it’s that it’s doing it in a way that’s smart and ambitious.

Brick and Mortar Stores are Like the Horse and Carriage of Retail, and Amazon is the Model T

And really, behind all of this lies a belief that the nature of retail is changing in a fundamental way that Amazon’s on the cutting edge of. We’re still a long way from Cyber Monday eclipsing Black Friday (well, Thursday now if you’re a Macy’s (M) employee), but that day’s coming. Online retail sales in the United States reached $231 billion last year. And, according to Forrester Research, that number should be $370 billion by 2017 and constitute 10 percent of all retail sales.

And nobody is coming even close to Amazon. Amazon currently outpaces everyone. By a lot. In fact, Amazon’s currently selling more online than the next 12 biggest online retailers combined. Yes. That’s how badly Amazon is kicking the crap out of everyone else in the industry. So if online retail keeps growing as projected over the next decade, and Amazon can maintain anywhere close to its current share of that market, you’re looking at a company that would be currently be underpriced.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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