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2 Reasons to Buy and 1 to Sell

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Investors sold off shares of (NASDAQ: AMZN  ) after the company announced earnings results for first quarter of the year. Is this an opportunity for long-term investors to grab a stake in this growing business or head for the exits with the rest? Read on, and I'll outline two of the best reasons to add Amazon to your portfolio and one reason to sell. 

Buy reason No. 1: Amazon's Prime service
Amazon Prime members pay Amazon $79 a year for unlimited two-day shipping on most products. And the service is a hit -- making Amazon the go-to destination for millions of new customers, with no end to the breadth of products that can be shipped to them from its growing base of warehouses. 

While the company doesn't share member numbers, independent estimates peg subscribers at 10 million -- and rising fast. 

Taking a page from Costco's successful retail model, Amazon engineered its Prime service to promote deep levels of customer engagement while padding the company's bottom line. Once shoppers are in, they're hooked. As members, they tend to look to Amazon to fill a wider range of product needs, from batteries to baby clothes. And Prime members are heavy users, too. They spend on average $1,224per year on the site, or double what non-Prime customers spend.

Amazon's main challenge here is to keep these members happy -- and to attract new ones -- mostly by boosting the number of products it offers with the addictive bonus of unlimited free, and fast, shipping.

Buy reason No. 2: CEO Jeff Bezos
Bezos is that rare founder/CEO who is completely focused on changing the world by delighting his customers. He's been called one of the best chief executives of modern business -- in the same league as Apple's Steve Jobs.

It's not just the fact that Bezos has delivered shareholder returns of 12,266% while boosting the value of his company by more than $100 billion. He also brings a rare mind-set to the business. As he explained in an interview recently, "Inventing and pioneering involves a willingness to be misunderstood for long periods of time."

One downside to that willingness is that Bezos and his management team don't share much information about their plans, or business, with investors. Kindle sales numbers, Prime subscriber figures, and online content spending are just three of the many data points that shareholders have to guess about, as management doesn't disclose them. For whatever reasons, Amazon keeps Apple-like secrecy not just on future products, but also on the success of current ones.

Still, there's no question that Bezos' financial interests are perfectly aligned with investors'. After all, he owns 88million shares in Amazon, accounting for nearly 20% of the entire company.

Sell reason: Valuation
Amazon is just not cheap. At $120 billion, the company is valued at twice last year's sales revenue. That premium is four times the valuation of even the most successful traditional retailers like Costco. And with a sky-high P/E ratio, the e-tailer will have to execute at an extraordinary level for years to justify that premium valuation.

Bottom line
While Amazon is already years into a big growth cycle, there are good reasons to believe the company can continue to expand from here.

Everyone knows Amazon is the king of the retail world right now, but at its sky-high valuation, most investors are worried it's the company's share price that will get knocked down instead of its competitors'. The Motley Fool's premium report will tell you what's driving the company's growth, and fill you in on reasons to buy and reasons to sell Amazon. The report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.

Read/Post Comments (3) | Recommend This Article (1)

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 May 12, 2013, at 1:43 PM, banmate7 wrote:

    It seems like the author didn't go far enough to connect the dots. Where will growth taper out & what would the ensuing valuation be...and, most importantly, where would that leave those who buy in right now?

    The valuation perspective seems to me the most salient one. You can make money in Amazon for sure. But it seems like any new investors could easily lose a lot of money when such a large cap's PE is normalized across time.

    It's not a question of "if", but rather of "when" the market will normalize Amazon's PE. For a value investor like me, who is willing to even pay a bit of a premium on a quality company, this is just to expensive & too risky.

    As such, I invested in companies like Intel, Corning, National Oilwell Varco, and Caterpillar recently. In light of these alternatives, why would I buy into Amazon at this point in time?

  • Report this Comment On May 12, 2013, at 8:37 PM, TMFSigma wrote:

    @banmate - thanks for the comment. I doubt many value investors would be tempted by even a big dip in Amazon's shares.

    But I wouldn't be so sure about that dip coming. The company has a lot of growth opportunities, and if the market hasn't turned on it after earnings tanked and cash flow plummeted over the last few years, its hard to see what would cause a big change in sentiment.

    -Demitrios (TMFSigma)

  • Report this Comment On May 12, 2013, at 10:43 PM, banmate7 wrote:

    Demitrious, you indeed might be right about "when". But I have seen markets time & again eventually correct a high valuation. This makes Amazon simply to risky for somebody with my investing style.

    Consider a $120 billion market cap, a forward PE of 192, and PB of 14. Do you really see growth in revenue & profits being able to bring this stock to a normal PE for a large cap? At $120 billion market cap, I just don't see how much more room Amazon has to make this happen...without a serious correction in price.

    I don't recall Google or Microsoft having such valuations during their ascendancy (correct me if I am wrong here). I am very wary of such valuations.

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