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.
click to enlarge
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%.
click to enlarge
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.
I was surprised to see this opinion piece as the "headline article" on Forbes.com. The analysis is flawed in several ways: (1) Amazon cannot realistically be compared to Google and Apple - it is a vastly different company. Amazon is an online retailer and their success will be predicated on achieving greater economies of scale, which is a very different model than Google or Apple. (2) The analysis focuses on short-term profitability and ROE as opposed to long-term growth. I would view an investment in Apple to be much shorter term, as their success is reliant on continued development of desirable new products they can sell at a high margin. Amazon, on the other hand, has invested significantly in capacity and infrastructure to deliver its products at a lower cost and has ramped up advertising to spur continued revenue growth - an approach that entails a slower growth trajectory. (3) Finally, this analysis - like most fundamental analysis - considers an investment to be nothing more than buying a right to current and future earnings (and perhaps more specifically, cash flows). An investor purchases shares of a BUSINESS, so any analysis on fundamentals does not capture the full picture.
In my opinion, Amazon's shares are more likely to hit $80 as a result of a stock split than due to a massive sell-off or the presence of a so-called bubble. Either way, I'm confident in my INVESTMENT in Amazon as a BUSINESS...the earnings and cash flows will continue to come.
I'm not a financial person, but I am a tech person, so I'd like to respond to Neil Tatay, who says Amazon is not a tech company. In fact, Amazon is just as much about technology as they are retail. Consider that they have created one of the most monolithic and ubiquitous networks for computing, AWS. It is a massive grid of computers that powers not only Amazon.com but countless other web services like Engine Yard, one of the premier hosting platforms. And it's not just one service, it's a stack of them: S3, EC2, SNS, SQS, SimpleDB...and more. Amazon's tech offerings are now relied upon (particularly S3 and EC2) by countless industries needing cheap storage and computing power, including, at one point in time, Twitter.
Furthermore, Amazon has invested massively in E-Ink with its Kindle. They have also spearheaded digital publishing and distribution technologies and standards via the books you can purchase for Kindle.
The retail part of Amazon really only tells part of the story, and it's very fitting they be compared to Google and Apple. Like a glacier, all of these companies have a little bit of their companies peeking out above the water for all to see (Amazon, retail; Apple, computers; Google, search), but the rest of the companies are massively technologically-backed that one doesn't really think about (Amazon, AWS; Apple, OS X, iOS, hardware, etc; Google, engineering).
I'm surprised this opinion piece is the headline story on Fortune.com. In MY opinion, this post is extremely one-sided and falls flat in fairly assessing an intriguing company. Amazon cannot be compared to Apple or Google as it is a vastly different company. Furthermore, investors purchase shares in a BUSINESS, not merely in future earnings growth or cash flows. So, simply focusing on the fundamentals is critically flawed. I suppose this rubbish article actually got me fired up and commenting, but it certainly didn't help my opinion on Forbes as a whole for publishing it...
LOL! Thanks Andy. I was just ranting about the same metrics, yesterday. I have never understood what the Amazon investors are looking at?!?
I work at amazon there problems with worker costs are just starting the unions,are about to start recruiting perm/temp staff to organise. The amazon way in wales is similar to the way they treated the miners in days gone by..or simply put the shit is about to hit the fan.
Amazon and Netflix's stock price movement is almost the same. They also have no store outfit for the retail investor to judge on. All investors fellow the stock base on the earning reports and analysts comment. Their report is so general and don't very unclear and focus only a few figures for analysts to recommend on.( Remember AOL.) Also, the insider holding is around 20% of the outstanding shares. I think that's not surprising to see its same behavior
I agree with most of what you said in a very one sided post, but you made one mistake: Amazon is valued at 68 Billion and Apple is valued at 231 Billion. Also, Apple has to continue to come up with new products while Amazon just has to sell them.....Dave
Amazon's stock price and movements are a perfect example of why the retail investor is getting out of the market. Analysts upgrade it after the price has run up $60, while full year estimates have been coming down over time. Comoputers have taken the place of fundamentals in determining a stock price.
Great to see Andy contributing to Fortune and a great article with great advice. The one point I'd add to your article is that Apple has consistently beat the streets forecasted growth by a wide margin. If you look at Apple's top and bottom line growth for the last 5 years you will note that it is substantially larger than Apple's assumed growth rate going forward. Apple's growth rate has accelerated in those 5 years and is still accelerating today. Assuming the street is just as wrong as it has been in the past about Apple's growth, then Apple's PEG is substantially understated as reported in your article. Either way, a great article.
Agree with your sentiment and conclusion. My only criticism is the choice of comparative companies. Amazon, despite being an internet based business is for the most part a retailer, not a technology company. I think some investors feel it has the potential to become the online equivalent of a Walmart. Either way it is an exhorbitant price to pay for that remote possibility.
Screen name (Select one with 3-12 characters; Numbers and letters only)
Enter your e-mail address below and we will send you an e-mail with a link and code to reset your password.
Already have the reset code?
Reset code
New password
Password
Forgot password?
Not a member yet?
Screen name
Password
Type what you see in the grey box
CNNMoney will use the information you submit in a manner consistent with our Privacy Policy. By clicking on "sign up" you agree with CNNMoney's Terms of Service and Privacy Policy and consent to the collection, storage and use of this information in the U.S. subject to U.S. laws and regulations. (learn more)
Read Full Article »