Amazon Stock Still Wildly Overvalued

You wouldn't know it by the stock's performance, but Amazon (NASDAQ: AMZN  ) has actually missed earnings estimates for three straight quarters. Investors have looked past the misses because the company is growing, but Amazon can only play the "investing in the future" card for so long before it'll have to prove it can make a profit. When the company reports first-quarter earnings on April 25, investors are only expecting a $0.09-per-share profit, and a miss of this low bar could send the stock crashing.

There are a few red flags for investors interested in Amazon, and soon we'll find out if those issues got worse in the first quarter or began improving.

The growth engine is slowing
One of the major challenges for Amazon is that growth is slowing. Normally, this is when investors would begin demanding profit to pick up, but thus far Amazon has gotten a pass.

AMZN Revenue Quarterly YoY Growth Chart

AMZN Revenue Quarterly YoY Growth data by YCharts.

Revenue is only expected to grow between 14% and 26% in the first quarter, so there's a strong likelihood the decline in growth shown above will continue. Amazon is starting to fight the law of large numbers, finding it harder to find growth on a relative basis even if the numbers are strong on an absolute basis.

Can you make money giving away shipping?
I'm an Amazon Prime user and I love the service the company provides. But I love it because I can buy absurdly cheap items and get them shipped to me for a one-time annual fee that comes with other goodies like streaming video. It's this free shipping that has become an issue for Amazon.

To give you an idea why it's a concern, yesterday I bought an item for $5.66 and right now Amazon is shipping to me from Hong Konk -- for free! There's no way that purchase has a positive gross margin for Amazon, and it's just one example of why the company is barely profitable at its core business.

In 2012, fulfillment costs were 10.5% of sales, up from 9.5% in 2011. This general trend upward doesn't show any sign of stopping as it pushes customers toward a shipping-included model.

It'll be interesting to see where margins are trending this quarter and if shipping costs continue to eat up a growing portion of sales. Amazon is trying to fight the higher shipping costs with more distribution centers closer to customers. So far, that hasn't helped the numbers.

Low-margin businesses
The core problem I see for Amazon is that it competes in fundamentally low-margin businesses. Online retail, cloud computing, and streaming video have price pressure and cost pressure, which means razor-thin margins. In tablets, Amazon has said it will sell devices at no margin in the hopes of making money on the back end. This compares to a wildly profitable model for Apple, which makes money on devices and the back end.

Razor-thin margins are why Amazon is bouncing near breakeven on the bottom line and why its stock trades at absurd multiples. If Amazon can't prove that it can make a profit eventually, investors will give up on this highly valued stock. After all, how much would you pay for a company that doesn't make any money?

Lowered expectations
Despite the strong performance of Amazon stock, the expectations on Wall Street keep getting lower. 2013 earnings forecasts have fallen from $1.74 to $1.48 over the past three months. For 2014 the same number is down from $3.93 to $3.57. Eventually, falling estimates will come back and bite a company, and eventually, investors are going to need to see profit on Amazon's horizon.

When you compare Amazon stock to a company like Apple, it's hard to see the value. Apple has a 8.6 forward P/E ratio and pays investors a 2.5% yield, compared to a 76 forward P/E and no dividend for Amazon. That doesn't sound like a good deal to me. 

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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 16, 2013, at 12:22 AM, krishnavajjala wrote:

    I’d appreciate author viewpoints and would have been a great article if it was a multi-dimensional analysis. I'm not sure on what basis author assumes that free shipping is a factor that determines AMZN's profit margins. IMHO no company or an individual would expend business at a loss fundamentally. The other side of the coin - investing in future business - it seems that the author wish to see companies to lull in profits- only then it would be profitable for investors! strange though!! - if that's the case Business continuity would be at stake and how long would one expects to see profits continuously without business diversity? From where can one invest to diversify Business without profits? Does not mean that profits are the only source to diversify business. Business diversification comes into the picture only when a company has ‘Growth.’

    It will not be an overnight jugglery to show profits with continuous investments. How would a company or an Individual can continue investing in future business if there are no profits? Why don't one can see company's profits in newer investments? Obviously one cannot reap a crop just the day after seeding.

    Bottom-line...look at AMZN's success in business diversity, foraying into markets (new and existing) by vast product category expansions...Certainly great leadership strategy to penetrate into markets and profits will definitely follow!!!

    Ps: These are my views and not intended to describe whether I'm short/Hold/Sell AMZN shares.

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