Throw This Stock Away

The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, Amazon.com (Nasdaq: AMZN  ) .

Prime of the century  
I give Amazon so much of my money that it's only fair that I send it back some venom.

Last night's quarterly report was a pyramid of cheerleaders. It's applause-worthy at the top, but wobbly knees begin to shake at the bottom from all of the weight.

Amazon has every right to brag about its $9.86 billion in revenue during the period, which was 38% ahead of last year's showing. Analysts were settling for $9.5 billion in net sales. The leading e-tailer is also targeting revenue to climb 35% to 47% for the current quarter. Go team! Go!

Things get more U-G-L-Y on the way down to the bottom line, with earnings of $0.44 a share, shaving a third of where it was a year earlier. Wall Street was banking on a profit of $0.61 a share. Amazon is a company that used to routinely breeze past analysts' income marks, but it has now come up short in two of the past four quarters.

It's not just a matter of cutthroat pricing on the Kindle to keep its e-reader on top. Barnes & Noble (NYSE: BKS  ) may be giving the store away for the sake of its Nook, but Amazon's 23% in gross margin during the period matches last year's first quarter showing.

The real carnage is taking place elsewhere. Fulfillment costs spiked 57% as subsidized shipments fuel Prime memberships. Marketing and technology overhead is climbing even faster. It's not pretty when so many line items are outrunning what seemed to initially be an impressive 38% top-line spurt.

The stock closed yesterday at what is now a dizzying 79 times trailing earnings. It's not going to get any better in the near term. Amazon sees operating profits falling by 9% to 65% in the current quarter, so the pros who were expecting bottom-line growth are going to have to revise their guesstimates lower.

Bulls will argue that Amazon isn't an earnings story. Its multiples are more attractive on a free cash flow basis. Well, trailing free cash flow of $1.9 billion is 18% below where it was a year ago, jacking up Amazon to a stiff 45 times free cash flow.

We also have to consider the taxing dilemma at the state level. More and more legislatures are angling to offset budgeting shortfalls by proposing that online merchants with affiliate marketers in their states begin collecting state sales tax.

It's also hard to get too excited about the revenue-generating power of digital media delivery. Amazon just kowtowed to allow free library lending, a move that matches the competition but will come at the expense of fewer outright e-book sales.

I remain a fan of Amazon and Jeff Bezos. I also recognize that this has been a winning Motley Fool Stock Advisor recommendation. It's been a juicy 11-bagger since David Gardner singled it out nine years ago. However, the stock's valuation is too heavy at the moment for its wobbly knees.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

  • Netflix (Nasdaq: NFLX  ) : Fellow dot-com darling Netflix is holding up better than Amazon on the fundamentals front. The video smorgasbord specialist came through with a strong quarter earlier this week. Netflix's free cash flow and operating margins clocked in at their highest quarterly levels in years -- something that obviously can't be said about Amazon. The two bellwethers are now direct competitors. Amazon began offering Prime loyalty shopping members streams from a limited catalog at no additional cost. If it really wants to compete against Netflix, it will have to dramatically ramp up its content licensing, and that's something that will contract margins even more.
  • Overstock.com (Nasdaq: OSTK  ) : Comparison shopping is far too easy these days. It's not just an e-tail affair. Smartphone owners have access to free barcode scanning apps that instantly retrieve the best local and web-based prices. The leveling of the playing field makes it hard to get excited about traditional bricks-and-mortar chains and conventional online retailers. Overstock should hold up better with its deeply discounted brand name overruns. Overstock reports tomorrow, and it's coming off a better than expected holiday quarter.
  • Apple (Nasdaq: AAPL  ) : There aren't a lot of gems in the web-based retail of physical goods. Blue Nile (Nasdaq: NILE  ) has been a standout in its niche of high-end jewelry, but the growth isn't as glistening as some of its precious rings. Analysts see flat earnings growth on a mere 5% revenue uptick in next week's Blue Nile quarterly report. Travel to the other end of the world and E-Commerce China Dangdang (NYSE: DANG  ) -- the online retailer often called the Amazon of China -- is struggling to generate net margins in the pathetic 1% to 2% range. I may as well go with Apple, a company that knows how to turn a profit and will continue to be the maker of choice of the gadgetry that feasts on digitally delivered media.

I'll keep shopping through Amazon, as long as it's not Amazon's stock in my cart.

Blue Nile is a Motley Fool Rule Breakers choice. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. Alpha Newsletter Account, LLC has bought puts on Netflix. Motley Fool Options has recommended a bull call spread position on Apple. The Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story, except for Netflix. Rick 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 (5) | Recommend This Article (5)

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 April 27, 2011, at 5:44 PM, tashchuk wrote:

    I like this column. Some real food for thought. Plus, it's nice to see a contrarian opinion on Amazon from a Fool.

    I'm not sure about NFLX. Yes, on some comps NFLX is better than AMZN. But, IMO, they're both overvalued.

  • Report this Comment On April 28, 2011, at 8:56 AM, Sparticus501 wrote:

    Rick's analysis lacks logic. He trashes the stock, but says he gives Amazon "so much of his money." Barnes and Nobles is going broke and buyers are turning to Amazon. Amazon is inching in on Netflix streaming videos, even if the take a small share of this market they make millions. Amazon is now selling an affordable tablet. Amazon is not a company that you look at on short term quarters, but long term solid fundamentals. One less impressive quarter is no reason "throw this stock away."

  • Report this Comment On April 28, 2011, at 11:01 AM, David369 wrote:

    I think Amazon has grown to monster size which is good but I think it is to the point that feeding the monster to keep it operating at current levels is so demanding we will never see the large rise in stock price as in the past. It is a good big company now and like most large companies it is rare to see large increases in stock price unless there are unique offerings or situations that significantly increase profit margins. Apple can come out with a new or different gadget and pop the price up until the next tech toy. Amazon has the kindle which it is probably selling at or below cost. I do think that even though kindle isn't really directly generating money for Amazon, their plan is to sell more e-books which I assume leads to higher profit and less handling/labor costs.

    Consider that Amazon sold more books than B&N and Borders combined. Over half of the books sold were e-books. The e-books will probably keep upping their profit margin and overall sales will probably increase but it think there will be a leveling off in overall growth from the US aspect. Of course, they can and are doing the same thing Wal-mart does to increase growth and that is going overseas.

    I wonder when B&N will fall victim to the Amazon monster? I like and use Amazon but it is still kind of nice to walk into a book store and actually browse. Besides, if all the local bookstores go under where the heck will I go to peruse the magazines? No where else has the selection/variety.

    I'm holding on to my Amazon stock. I just don't expect as much from it.

  • Report this Comment On April 29, 2011, at 10:46 AM, caltong08 wrote:

    I think the writer writes with too much emotion and ego. If he has something serious to say, it should be said with more serious language and more thoughtful analysis. Otherwise, he should find a job with Jim Cramer.

  • Report this Comment On April 30, 2011, at 9:43 AM, jorgeca wrote:

    Rick your an idiot..... Remember nflx they wrote them off years ago. now look at them.... what you can predict is how the company will evolve.... amzn now will be streamlingn movies....

    how do you know dang will not evolve other business that change the margins..

    you know nothing school boy...

    you are the fool

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