Can Amazon Justify Its Valuation?

From a distance,, Inc. (NASDAQ:AMZN) looks quite overpriced. With half its current year’s books public knowledge, Wall Street analyst consensus is for 71 cents per share of earnings for 2012. The stock price currently sits at about $250- a current-year P/E multiple of 352. This is expected to be a temporary setback, as for 2011 Amazon turned in $1.37 in EPS and the figure for 2013 is anticipated to be $2.33. However, even taking the forward earnings estimate yields a P/E of over 100. Maybe the stock price is justified by enormous growth over the next few years? Not quite: the five-year PEG ratio is 10. That is more like what we see in a forward earnings multiple for some companies!

Here is another way of looking at it: analyst consensus is that Amazon will see an average 37% growth rate in its earnings over the next five years. If we apply that to last year’s $1.37 in earnings per share, the company should finish 2016 with $6.61 in earnings per share. So the stock is trading at 38 times the earnings it is expected to earn in 2016. Here’s a third perspective: Apple Inc. (NASDAQ:AAPL) has grown its earnings at an average rate of 73% over the last five years. Apply that growth rate to 2011’s $1.37 in EPS, and Amazon finishes 2016 with $21.23 in earnings per share. The current share price is 12 times that figure. So in order for us to see Amazon as a buy, we would have to be confident that it can grow at least as fast over the next five years as Apple did over the last five. Amazon’s net sales were 29% higher in the second quarter of 2012 compared to the same period a year ago, but the company’s costs also rose. As a result the company saw considerably lower margins and net income.


Yet a number of hedge funds thought that Amazon was worth including in their portfolios in the second quarter- 50, according to our database of 13F filings, putting Amazon on our list of the ten most popular services stocks among hedge funds (see the full list). For example, Amazon is one of Blue Ridge Capital’s top stock picks (find more stock picks from Blue Ridge Capital); Blue Ridge is run by John Griffin, who was formerly Julian Robertson’s second in command at Tiger Management.

Obviously one of the most intriguing opportunities for Amazon is its plan to achieve same-day delivery in major U.S. cities, using a portfolio of stocked warehouses near these urban areas to ensure that a variety of goods will not require shipping from a more distant facility. The company’s Kindle line of e-readers and tablets are another potential growth driver: while competition is heating up (read our analysis of customer satisfaction trends in the tablet industry) and pure e-readers are being threatened by lines of relatively cheap and more functional tablets, Amazon is giving buyers of its Kindle a hotline to watch their videos over those of competitors like Netflix, Inc. (NASDAQ:NFLX) and buy their products over more traditional brick-and-mortar retail outlets.

Given the range of business trends Amazon is tied to, we would go with a peer group consisting of Netflix, Apple, Google Inc (NASDAQ:GOOG), and Best Buy Co., Inc. (NYSE:BBY). These companies cover content delivery, tablet devices, and retail (Best Buy is reportedly struggling to compete with Amazon in electronics retail). The technology companies are heavily discussed, but we’d just note that both Apple and Google have turned in better growth rates than Amazon over the last several years and yet trade at forward P/E multiples in the teens. We would say that either is probably a better buy. Struggling Netflix’s stock price is down about 50% from a year ago, and its earnings are falling as the company has been forced to increase its expenses. The company trades at 61 times forward earnings estimates, still well below Amazon’s territory. The two companies are actually quite comparable, as they both depend on major growth initiatives (dominance in streaming video without content acquisition costs going through the roof, in the case of Netflix). Best Buy clearly in decline (earnings last quarter were down 91% from the same period a year ago) with few hopes for a rebound; at 6 times forward earnings estimates and a 4% dividend yield, it would have to be considered on a value basis and even then investors should be worried about future profitability.