Worst Stock for 2008: Amazon.com

Resolve to keep your portfolio healthy: Help us pick the worst stock for 2008.

So the old year is over, and good riddance, right? Now you want to know how to avoid repeating last year's mistakes in the new year. You want to know which stock to avoid in 2008. Well, I've got just one word for you: Amazon.com (Nasdaq: AMZN  ) . Or does the "dot-com" part count as a second word?

No matter. Whatever the number of words, Amazon is a zero in my book. (Pun intended.) After more than doubling in 2007, this stock has had its time in the sun. But miracles seldom repeat, and high-priced miracles in a recessionary economy are rarer still.

The bull case
Before laying waste to Amazon, let's give credit where credit is due -- this is one superb company. Over the five years since we picked it to join the Motley Fool Stock Advisor portfolio, Amazon has more than quintupled in value. That doesn't happen by accident. It happened because Amazon has made itself the undisputed king of e-commerce. When you want to buy something on the Web, you make Amazon.com your first stop. Full stop.

Sure, bargain hunters like Yours Fooly tend to use that stop more for checking product reviews and finding a ceiling on what an item should cost. We then quickly float on out of Amazon, to find better deals at Overstock.com (Nasdaq: OSTK  ) , Drugstore.com (Nasdaq: DSCM  ) , and eBay (Nasdaq: EBAY  ) . Or we'll hop in the family roadster for a price check at Costco (Nasdaq: COST  ) or Wal-Mart (NYSE: WMT  ) .

If, like me, you put profits high on your stocks wish list, then just take a gander at these numbers:

Trailing 12-Month (TTM) Sales

Operating Margin (TTM)

Price-to-Sales Ratio

eBay

$7.2 billion

25.4%

5.6

Amazon.com

$13.1 billion

4.4%

2.7

Drugstore.com

$436.1 million

(3.2%)

0.7

Overstock.com

$762.9 million

(7.7%)

0.4

Source: Capital IQ (a division of Standard & Poor's) and Yahoo! Finance.                    

Which of these things is not like the others?
When it comes to e-commerce stocks, the undisputed king of the hill is not Encyclopedia Amazonica, but auction-star eBay. It's got the second highest sales. The fattest operating margins. The highest price-to-sales ratio.

Huh? Wait a minute.
I know what you're thinking. If I don't like Amazon because it's a "high-priced miracle," then what am I doing praising eBay, when its price is even richer?

Well, the answer is that unlike Amazon, eBay deserves its lofty multiple. And, for different reasons, the unprofitable also-rans Drugstore and Overstock deserve their miserly multiples. You see, unlike Drugstore.com, Overstock.com, and Amazon.com, eBay carries no inventory. As a pure play e-commerce "facilitator," it doesn't need to. Every incremental additional sale eBay adds to its income statement brings essentially pure profit, as the company plays gatekeeper and toll collector on the E-Commerce Superhighway.

In contrast, Amazon hasn't just abandoned its founding raison d'etre -- selling stuff electronically, while letting the actual makers of the stuff handle distribution. It's actually becoming steadily more bottom-heavy on its balance sheet over time. If you examine Amazon's balance sheets for the past five years, I think you'll be surprised to learn that while sales have grown mightily -- up more than 200% since fiscal 2002 -- the inventories Amazon must carry to facilitate those sales are growing even faster, weighing in nearly four times heavier at last report than they were averaging five years ago.

Starting over from scratch
Judging from its actions, Amazon recognizes this problem, too, and is taking steps to address it. As fellow Fool Alyce Lomax so ably argued last summer, Amazon's throwing an awful lot of spaghetti at the walls lately, in an attempt to make something less inventory-dependent stick. A new payment service was one. Amazon Unbox was another.

Most notably, the firm's new Kindle e-book seems designed to reverse Amazon's flow back toward Jeff Bezos' original intent. Selling downloadable "virtual books" will, by definition, require less inventory -- at least of books, if not of Kindles. And maybe this gambit will work. But judging from the stagnant performance of fellow virtual-book seller Audible.com (Nasdaq: ADBL  ) over the past couple years, I have my doubts.

Foolish takeaway
So you see, there are many reasons to shy away from Amazon.com stock in the New Year. But for me, the biggest reason is the price.

I don't see any need to go into detail on this one. You see Amazon's trailing price-to-earnings ratio of 97, its 23% projected five-year growth rate, and its PEG of close to 4.0. You look at those numbers, and you know instinctively: It costs too much.

Listen, I know you love Amazon. And if you own it, I know you treasure your gains of yesteryear. But now, it's time to face facts and own up to the obvious. If you agree with me, go to Motley Fool CAPS, and admit that at this price, Amazon is certain to underperform in 2008.


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