The amazing Amazon stock bubble
October 22, 2010 10:31 AM
The online retailer's shares are valued at more than three times Apple's and more than two times Google's. And there's no reason why.
by Andy M. Zaky, contributor
Whenever a stock can potentially drop 50% and still be considered overvalued, that's when you know the stock is a bubble. Amazon (AMZN) far surpassed bubble territory ages ago but investors still continue to plunge billions of dollars into the company. If the stock were to crash to $80 a share today from $164, it would still be trading at a significantly richer valuation than Google (GOOG), Apple (AAPL) or even Research in Motion (RIMM).
While Amazon continues to execute at a very high level – yesterday it reported better than expected sales growth of 39% and earnings growth of 16% -- the stock still trades at a very lofty 67 P/E ratio. That's more than triple Apple's 20.1 P/E ratio, or Google's 24.6 P/E ratio. Even more striking is that the company trades at 2.31 times its expected 5-year growth rate, which indicates that the stock has gotten way ahead of itself. Ideally, a company should trade at no more than a 1:1 PEG ratio unless the company has a consistently proven track record (like Apple) of far exceeding analyst expectations.
By comparison, Apple only trades at 1.11 times its 5-year expected growth rate, Google at 1.23 times and Research in Motion at only half its expected growth rate. Yet, all of these companies are expected to grow at more or less the same level. Only Amazon trades at a valuation that far exceeds any semblance of reality.
Analysts expect Amazon to report earnings of roughly $2.59 in earnings per share on $33.3 billion in revenue in fiscal 2010 compared to $3.57 in EPS on $41.63 billion in revenue for fiscal 2011. Based on these estimates, the company is expected to grow at a roughly 37.8% pace next year. Yet, the stock trades nearly 46 times next year's earnings. While Amazon is trading at only a slight premium to its 12-month expected growth rate, the loftiness in its valuation arises out of three distinct issues.
Amazon vs. Apple
First, when looking farther out, analysts are modeling for a more tempered 25% growth rate for Amazon over the next five years. Based on this expectation, the stock shouldn't be trading at a significantly higher premium than 25 times next year's earnings. This is exactly why, though Apple is expected to grow at a pace of 35% in 2011, the company trades at only 15 times 2011 earnings. Analysts expect Apple to grow at a pace of 19.2% over the next 5-year period and as a result, it trades at a fair 20.1 trailing P/E ratio.
Which brings us to our second, and more important problem for Amazon's current lofty valuation. Why should someone pay 46 times next year's earnings for Amazon at when they could buy Apple at mere 15 times next year's earnings, Google at 19 times or Research in Motion at only 8 times next year's earnings? Why should Amazon be given a more lofty valuation when analysts not only expect roughly the same out of Apple over the coming five years, but the stock trades at only a third of Amazon's outlandish valuation?
It absolutely makes no sense, especially when one considers the fact that Amazon has far underperformed on both the top and bottom line when compared to Apple. While companies are valued based on future expectations, there's something to be said about how a company is actually performing. Especially when what is expected out of all four of these companies is more or less the same.
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While Apple's top line growth has been accelerating over the past year, Amazon's growth rate has been decelerating. On the top line, Apple posted roughly 31% growth in calendar Q4 2009, 48% in Q1 2010, 61% in Q2 2010 and 66% in its recently reported calendar Q3 2010. Amazon, by comparison, grew its top line at a pace of 40% in Q4 2009, 45% in Q1 2010, 41% in Q2 2010 and roughly 39% in Q3 2010. Yet, while Apple continued to struggle with a P/E ratio ranging from 15-20 over the past year, Amazon consistently traded between a 55-70 P/E—nearly three times the valuation placed on Apple.
And while earnings is the key determinative factor in valuation, top line growth in many ways is far more important than earnings per share. A company can always reduce costs and improve margins to move more of its revenue to the bottom line, but the hard part is actually producing, marketing and selling a product that people want to buy. It's much harder to make money than to cut costs, and sophisticated investors know this.
Yet, that being said, Apple is outperforming Amazon on the bottom line as well -- by a much larger magnitude than on the top line. While Amazon has been posting growth in the range of 13%-63% over the past year, Apple has grown at a pace of between 47%-86% over the past four quarters. And in 2009, the disparity between the two companies was even more pronounced. In fact, in this recent earnings season, Amazon grew at the slowest pace of the "four horsemen," despite having the highest valuation. RIM, which only trades at an 8 P/E ratio, grew at a significantly faster pace of 40% this quarter—compared to Amazon's anemic 16%.
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Finally, when analyzing enterprise value (Market Capitalization minus Cash & Cash Equivalents) and the return on equity, it becomes strikingly apparent just how overvalued Amazon really is compared to Apple, Google and Research in Motion. If some company were to purchase all four of these companies, it would get the lowest return on equity with Amazon. For the $68 billion used to purchase Amazon, the buyer would have only returned 1.6% on the investment over the past year at the current enterprise value.
With a straight purchase of Apple at a $231 billion, by comparison, it would have yielded a return of almost 6.1% or nearly 3.81 times the return from Amazon. For Research in Motion, a purchase of the company for $23 billion would yield a return of 8.7%, and for Google, an outright purchase of $162 billion would yield a return of 4.6%. This is based on what each of these companies actually earned over the course of the past year at the current enterprise value.
Obviously, future earnings are more important than past performance, but analysts are generally modeling for similar growth rates for each of these companies going forward. This suggests that these results won't be substantially different next year than they would have been this year.
The bottom line is this: Amazon trades at more than three times Apple's current valuation, eight times RIM's valuation and just about two and a half times Google's valuation. This is simply way too high. Nothing in the company's performance supports the current price level. When RIM was trading at $150 a share, sophisticated investors knew the stock was a bubble. This case is no different. There is no matter of 'if' in this analysis. It's a matter of 'when.' Amazon will lose 50% of its value over the coming years. At $150-$160 a share, investors are flirting with financial suicide.
Don't short bubbles, and don't buy bubbles. Just get out of the way.
Andy Zaky is a graduate from the UCLA School of Law, and editor of Bullish Cross. His main area of emphasis is in global macro-economics, fundamental analysis and technical analysis. Andy also regularly follows and conducts financial statement analysis and quarterly earnings projections for Apple and other high profile tech stocks.
