Amazon Investors Must Look Out for These Trees

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If (Nasdaq: AMZN  ) had a nickel for every time an analyst has praised its business, it'd make money like, well, Amazon. But this stock isn't all made up of whatever the financial world's equivalents of puppies and unicorns are, so what are the cracks in its business?

Potential suffering from sales taxes
Amazon escaped from collecting state sales taxes for many years in states where it didn't have warehouses, but facing budget shortfalls, governments have acted to get their share. For example, starting in September of this year, Amazon will be required to collect and pay the 7.25% California state sales tax along with any local taxes. Many think this will even the playing field with rivals like Target (NYSE: TGT  ) . According to BusinessWeek, "Target's effective tax rate in 2010 was 35.1%, compared to Amazon's 23.5%." Consumers may not shop online once they are unable to avoid paying sales tax, right?

Well, one study from Consumer Edge Research shows little difference in shopping behavior with or without sales tax. In a state where it does collect sales tax, like New York, it owned 58% of online movie and DVD purchases, whereas in a state where it doesn't yet collect sales tax, like Indiana, it owned 62% of these purchases. And for clothing, Amazon captured a higher amount of sales in states where it did collect sales tax.

Additionally, Amazon actually can benefit from sales taxes. For one thing, Amazon launched a service in February where it charges 2.9% of all taxes that it collects for its Marketplace Professional vendors. Additionally, Amazon has actually supported federal legislation allowing states to collect sales taxes from online retail. Some believe it is because if all online retailers had to abide by these laws, smaller competitors would be hurt by the increased burden of complying with several different states' tax codes, like small businesses that sell goods on eBay (Nasdaq: EBAY  ) . As eBay Vice President Tod Cohen testified in Congress, "giant retailers are lined up united in proposing a change in remote sales tax law that will harm the smaller retailers who do not have a national physical presence." The same retailers who have "always been at the heart of the eBay business model."

"Cult of Prime" killing margins
There's no doubt a subsection of the population that would never leave their house if vitamin D could be delivered directly to their door, and for them Amazon Prime provides not only physical goods but digital entertainment as well. But for everyone who orders a pack of gum and has it delivered within two days, Amazon's profit margins take a hit, and the cost savings from having no brick-and-mortar stores disappear. Combined with new warehouses and selling the Kindle Fire at a loss, Amazon's profit margins are floundering around Best Buy's (NYSE: BBY  ) levels, and much lower than Wal-Mart's (NYSE: WMT  ) :

AMZN Profit Margin Chart

AMZN Profit Margin data by YCharts

While Best Buy looks to aide margins through opening 800 new smaller footprint locations by 2016, Wal-Mart's sales continued to grow by almost 6% last quarter. Of course, Amazon CEO Jeff Bezos thinks beyond these quarter-to-quarter changes -- he's even funded the building of a clock meant to keep time for 10,000 years. And in an interview with Wired magazine, he states, "We'd rather have a very large customer base and low margins than a smaller customer base and higher margins." And no doubt Prime and the Kindle Fire is all about building that customer base.

All on Bezos' shoulders
Bezos has been named Time's Person of the Year, and no doubt investors price in his seemingly endless ideas for Amazon to hold its P/E of 147. Not only can he find the engines from Apollo 11 on the seafloor, but he also can launch a cloud-computing division that now is estimated to earn more than $1 billion in revenues. There seems to be so much vision inside Bezos it has no choice but to spill out among his many side projects, like his spaceflight company, Blue Origin.

Great management and vision like Bezos should give Amazon's stock a premium price, but what would its price be without Bezos? Imagine that one of his other hobbies becomes his career, and he gives up the CEO position – far-fetched, especially when he believes "it's pretty easy to wake up excited," but shareholders should have just as much long-term vision as Bezos himself. Could Amazon continue growing without Bezos' leadership? Or is the market even putting the right premium on the stock with him as CEO?

Playing the devil's advocate
Amazon has been a great stock for many, returning over 1,200% for the Motley Fool Stock Advisor newsletter service. Even if you remain on the bullish side of Amazon investors, it's to your benefit to look at what could change your investment thesis. For Amazon, it seems that collecting sales tax won't have a great effect on business, and low margins are part of Bezos' strategy. However, ask yourself whether you think the market is paying the right price for Bezos' leadership.

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Fool contributor Dan Newman pays taxes, and owns shares of Amazon and eBay. He holds no shares of the other companies mentioned above. Follow him @TMFHelloNewman.

The Motley Fool owns shares of Wal-Mart Stores, Best Buy, and Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, eBay, and Motley Fool newsletter services have recommended writing puts on eBay and creating a diagonal call position in Wal-Mart Stores. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (4) | Recommend This Article (4)

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 March 30, 2012, at 1:12 PM, jrj90620 wrote:

    I think the 8% price increase,due to the coming sales tax for California residents, is going to cause me to look to Ebay,where there will be no sales tax, and other sellers.It depends on the final price,but this should make Amazon less competitive with other sellers.

  • Report this Comment On March 30, 2012, at 1:37 PM, George513 wrote:

    As far as making/saving $ and eBay goes, forget the stock and use the website.

    If you see an item that you want listed in auction format, send the seller a message asking if they will accept $x to end the auction early and sell the item to you. If that doesn’t work, use a sniping service such as to bid for you. It’ll bid in the last few seconds, helping to save $ and avoid shill bidding.

    If there is a particular item that you want that is relatively rare on eBay or goes fast when one is listed, use to set up a saved eBay search for it. You’d get an e-mail whenever a match is listed. You can use the price, category, exclude word, etc. filters to narrow down the results that you get in the e-mails. Excellent for “Buy It Now”s priced right.

    If the item that you’re looking for is difficult to spell, try a misspelling search site like to find some deals with items that have main keywords misspelled in the title. Other interested buyers may never see them.

  • Report this Comment On March 30, 2012, at 3:41 PM, forthewin wrote:

    I tend to think the sales tax is not going to have a huge impact on Amazon's bottom line because its merchandise is still largely cheaper than retailers for most items.

    People who continue to talk about the P/E ratio are a bit misguided. Amazon has shown time and again that they are willing to sacrifice short-term profits for long-term growth and entrenchment. During times of massive infrastructure build-out profits are going to dip, but the expenses are short-term, while the growth prospects extend out decades. For a rapidly evolving business like Amazon, P/E ration takes on a much lower level of significance because you are taking last quarter's profits and dividing them by last quarter's costs. Investors have (wisely) figured this out and have traded the stock up (but not enough in my opinion- I still think $AMZN is a buy).

  • Report this Comment On March 30, 2012, at 4:08 PM, neuroelectronic wrote:

    I get my Vitamin D delivered to my door via Amazon...

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