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Amazin' Amazon Does It Again

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On Monday I asked, "Is (Nasdaq: AMZN  ) overvalued?"

Given the bullish reaction to last night's third-quarter report, I guess Mr. Market's saying "no."

Amazon headed toward the checkout line with another monster quarter in its cart. Net sales soared 28% to $5.45 billion, well ahead of analyst expectations of an 18% top-line jump. At the other end of the income statement, the pros expected earnings to climb merely 22% to $0.33 a share; instead, Amazon's profit soared 68%, to $0.45 a share.

Want even better news? Just follow the money. Amazon's free cash flow over the past year has nearly doubled, to $1.92 billion. With 451 million shares outstanding, we're talking about $4.26 a share in free cash flow alone. Just keep that in mind the next time a bear tries to justify a short position by relying on the company's significantly smaller reported profit number.

Yes, but what will you do for me tomorrow?
However, all these glad tidings don't make this an ideal time to dive in to the stock. When David Gardner recommended to Motley Fool Stock Advisor subscribers seven years ago, the company traded at $15.31. Depending on where the stock is trading by the time you read this, it may have gained that entire amount -- if not more -- in a single trading day. We call that a daybagger -- or a spiffy-pop -- around here.  

In retrospect, we'd all be gazillionaires. If someone told you in the summer of 2002 that you could buy Amazon for less than four times 2009's free cash flow, even patient bears would be buyers. So for today's envious, uncertain potential investors, it's only fair to ask the obvious question: Where will Amazon be seven years from now

Obstacles come in threes
To assess Amazon's opportunities, we must first take stock of its challenges. Katrina Chan broke out the primary threats to Amazon's model earlier this week:

  • Copycat retail sites
  • Direct competition to the Kindle
  • The need to find new revenue streams

I'm not worried about the copycats. Every couple of years, there seems to be a new, hungry upstart nipping at Amazon's heels., (Nasdaq: OSTK  ) , and even Wal-Mart's (NYSE: WMT  ) have all risen to the challenge, but Amazon's ultimately left all of them eating its dust. The power of Amazon's purchase-promoting Prime membership plan only gets stronger with every passing year. Even category specialists who step briefly into the market's spotlight -- Blue Nile (Nasdaq: NILE  ) with jewelry, or (Nasdaq: DSCM  ) with pharmacy-store sundries -- ultimately can't match Amazon's sustained growth pace.

The Kindle clones, I do take seriously. Barnes & Noble's (NYSE: BKS  ) Nook raises the stakes on what e-book fans will expect from of a $259 reader. Apple (Nasdaq: AAPL  ) is one iTablet announcement away from changing the way we consume digital books, magazines, and newspapers. The Kindle may be hot now, but there will probably never be one single e-book device standard -- the iPod, if you will -- to rule the land.

Even if Kindle never really catches fire, Amazon should be fine; there's so much more to its other competitive advantages beyond its current pole position in digital reads.

The same can be said about the need for new revenue streams. Amazon already serves up books, music, movies, and games -- its original media products -- in digital form. However, Amazon has dozens of other categories in its storefront, and we'll always need physical merchandise. Pressure cookers, windbreakers, and camcorders aren't going to download themselves, you know.

Even Amazon's digital initiatives all ultimately rely on hardware to play. As long as it remains the top dog in online retail -- and right now, no one is even close -- Amazon will be just fine today, tomorrow, and seven years from now.

Blue Nile is a Motley Fool Rule Breakers pick. Apple and are Motley Fool Stock Advisor recommendations. Wal-Mart Stores is a Motley Fool Inside Value selection. Try any of our Foolish newsletter services, free for 30 days. Now that's window shopping!

Longtime Fool contributor Rick Munarriz has been shopping online since the early 1990s, even before was around. He does not own shares in any of the stocks in this article. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 23, 2009, at 12:39 PM, desertjedi wrote:

    It's fascinating to read so many analysts shred this stock only to watch it blow through the roof weeks later!

  • Report this Comment On October 23, 2009, at 12:52 PM, mikecart1 wrote:

    AMZN is overbought, overpriced, and overrated.

  • Report this Comment On October 23, 2009, at 1:33 PM, tumachar wrote:

    Right now, AMZN is richly valued. Based on the money they plan to make for next 5 years, the price is too high.

  • Report this Comment On October 23, 2009, at 1:54 PM, SteveTheInvestor wrote:

    Personally, I'm convinced that "the market" is a bit psychotic after watching the happenings over the last 2 years. Buy.... don't buy....sell.... it's all becoming a bit of a crap shoot anymore.

  • Report this Comment On October 23, 2009, at 5:30 PM, funkywizard wrote:

    this article ignores the important factor here, where will the growth come from, and how much of it do you need to justify the current share price? If I could take shares of amazon or a hole in the head, you bet I'd take shares of amazon, but at what price would I put money in? If amazon growth slowed dramatically, it could be cut in half overnight. To go up from here, it will have to keep stratospheric levels of growth going for another 5 years.

    It may have made it's numbers this quarter, but turning $5 billion in sales into $25 billion is not nearly as easy as turning $1 billion into $5 billion. The current stock price is only a buy if they can pull off that significantly harder trick.

  • Report this Comment On October 23, 2009, at 10:56 PM, psytrader wrote:

    The article also fails to mention one of the biggest issues facing AMZN in the coming months which is the collection of state sales taxes. Right now, AMZN enjoys an advantage of not being forced to collect these sales taxes from online customers as other retailers are but this unwritten advantage will soon disappear IMO. This could put some pressure on AMZN sales Also, a price war with other online retailers is an inevitability, even Walmart is engaging in one in the ebook space. With the current cutthroat retail market, it won't take much to dent AMZN's margins. We shouldn't forget GOOG's ambition to catalog every book on the planet. AMZN has enjoyed a virtual monopoly with the Kindle but we all know that it's an entirely different game going into this holiday season. AMZN may be a great company but it would make me very nervous holding this stock after this runup knowing that an I-tablet annoucement from Appple could potentially cut future Kindle sales in half or more within one quarter. Apple would be wise to release their tablet before the holidays, it could very well happen. Barnes and Noble initially told the public that their Ereader would be out in the first quarter of '10 and what do you know, it's coming out for this holiday season! If Kindle is the best selling product at Amazon,a technologically superior product from Apple would have an immediate adverse effect on sales and profits. Caution is advised!

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