In the mid-to-late 1990s, Amazon.com (Nasdaq: AMZN ) burst onto the scene largely as an online bookstore. Its revolutionary model was expected to knock bricks-and-mortar competition like Barnes and Noble (NYSE: BKS ) and Borders (NYSE: BGP ) for a tremendous loop. After all, without the expensive overhead of retail stores, Amazon could profitably offer its products for a lower price. And with its huge, centralized warehousing system, it could have a much larger selection than any physical bookstore, giving customers unprecedented choice. With more choices and lower prices, investors thought that nothing could stand in the way of this star's ascent.
That is, of course, until the traditional retailers started fighting back, pressing their own advantages. In most bricks-and-mortar bookstores, you can now grab a specialty coffee and pastry, browse and read through the selections at your leisure, and even take a catnap on a comfortable couch. Not to mention the always-huge advantage of walking away with your freshly purchased merchandise that very same day.
On the flip side, consider the limits of Amazon's offerings. Its nearly useless "search inside this book" feature may let you get a glimpse at a handful of pages of some books, if you're lucky. Browsing through Amazon's online categories is far less stimulating and user-friendly than glancing through titles on a bookshelf. And if you want your book in anything resembling a timely manner, you'd better be prepared to pay through the nose. Expedited shipping charges usually more than offset whatever cost savings would come from Amazon's store-free distribution system. As a result of their successes in pressing their advantages, the stocks of bricks-and-mortar booksellers have managed to outperform Amazon's over the past couple of years.
Despite its competition's successful retaliation, Amazon has become a tremendous success story among online retailers, largely by expanding its product offerings. It now is an Internet-based general-purpose discount retailer, more akin to Wal-Mart (NYSE: WMT ) or Target (NYSE: TGT ) than a bookstore. Given that comparison, let's see how the three stack up, head-to-head:
|Sales||$321.13 B||$54.01 B||$9.25 B|
|TTM P/E Ratio||16.4||16.7||37.7|
|Quarterly Y/Y earnings growth||6.30%||12.10%||(57.70%)|
|Y/Y Share Dilution Rate||(1.44%)||(1.84%)||1.70%|
With Target and Wal-Mart, you get larger companies, with somewhat stronger profit margins and better short-term earnings growth, trading at cheaper valuations, with lower dilution and higher yields. Though Amazon has somewhat better projected future growth rates, given this valuation data, I can't quite understand why anyone would invest at its current price.
Some might argue that, as a smaller company, Amazon has more room to grow, and therefore deserves a higher relative valuation. The big problem with that theory can be summed up in one word: shipping. In order to remain competitive from a total cost perspective, Amazon eats the shipping charges on many items. For folks who want their products shipped faster, Amazon Prime runs $79 a year; it can easily save frequent buyers that much in a flash.
As a result, Amazon's continued expansion may mean increased profits for shipping giants United Parcel Service (NYSE: UPS ) and FedEx (NYSE: FDX ) . But when Amazon's huge loss-leader of shipping costs scale directly with the expansion of the business, it becomes increasingly difficult for continued growth to drive profitability. Amazon practically admitted as much in its recent earnings release, listing free shipping and Amazon Prime as contributors to a decline in operating income.
Putting it all together
With traditional retailers flexing their real-world advantages, price and selection are about the only competitive advantages that Amazon can exploit. In this era of discount titans like Wal-Mart and Target, however, the company loses a bit of its edge in that arena as well. With loss-leading shipping costs eating so much of its growth, it simply does not deserve the valuation premium the market has given it.
Despite this, Amazon will likely survive. As an investment, however, I'd stay away, unless and until its shares fall to a more rational level.