One Nightmare for Christmas

To celebrate the holidays, we here at the Fool are devoting extra virtual ink to all things consumer-focused in a special series called "The 12 Days of Christmas." Over the coming week, we'll have our "12 Days of Content" involving consumer-focused names that look set to profit or perish from the holiday cheer.

One year ago (nearly to the day), I led off the Fool's "12 Days of Christmas" feature with a salvo in defense of Amazon.com (Nasdaq: AMZN). A 40% profit later, it seems only appropriate that this year, I pick Amazon again.

To underperform.

Treason
Why do I turn coat on Amazon today? After all, the stock has outperformed the S&P 500 by nearly a 3-to-1 margin since I recommended it. "Where's the love?" you may ask. Where's the gratitude? But you're better off asking, "Where's the value?" You see, I'm not flipping on Amazon willy-nilly. From where I sit, the valuation proposition on this stock just isn't there anymore.

With Amazon selling for 73 times trailing earnings, and 52 times what analysts expect it to earn next year, I doubt there's a PEG investor out there who would argue that the company is a bargain at these prices. It's also much more expensive than the last time I looked at it. One year ago, with Amazon selling for 77 times earnings, I argued that the company was a bargain because -- among other things -- it was generating free cash flow at a rate more than three times as much as its reported net income. Free cash flow last year amounted to $2.9 billion, while the company reported $902 million of that as its net income under GAAP.

And today? Amazon's reported earnings are up, though not as much as its stock price. At $1.1 billion in net income, Amazon's 24% more profitable today than it was a year ago (at least, according to GAAP). Unfortunately, rather than rising in tandem, Amazon's trailing free cash flow figure now stands at just $1.8 billion -- about a 37% decrease from last year -- giving the stock an expensive 44 price-to-free cash flow ratio.

Keynes chimes in
In short, Amazon's valuation today is simply indefensible. It's stretched beyond any rational measure. Yet we all know that indefensible valuations can persist in spite of all rational argument to the contrary. Before you rush out to short Amazon.com, I'd advise you to heed the wise words of John Maynard Keynes: "Markets can remain irrational longer than you can remain solvent." Before Amazon.com can fall in price, a catalyst for such a fall must appear.

Unfortunately for Amazon "longs," I think I see that catalyst on the horizon -- in the form of the Great Recession.

Tax revenue, up in smoke        
A few years back, there was a big trend afoot of U.S. smokers "going online" to order their cigarettes tax-free. The Wall Street Journal even ran an article about a certain Swiss company that was making beaucoup bucks selling smokes online "duty-free," and shipping 'em to the States.

The federal and state tax collectors didn't like this one bit. Major cigarette manufacturers like Altria (NYSE: MO) weren't too keen on the idea, either. The offshore sales were stealing revenue Altria wanted to keep stateside, and there were allegations of copyright infringement as well. I don't need to tell you what happens when Big Business and Big Government find that their interests align. In no time at all, the offending company's American website directed traffic to Altria's site.

Now, fast-forward to today, and tell me whether you see the similarities: Across the nation, 46 out of 50 states are facing budget deficits as the Great Recession eats into their tax revenue. Meanwhile, the governors of those states are reading the annual round of retail Christmas cheer: "Record" online sales. Online spending up 12% over last year -- and Amazon's online sales doing much better than that.

Meanwhile, retailers like Best Buy (Nasdaq: BBY) and Wal-Mart (NYSE: WMT) are finding themselves regularly losing out to Amazon in product price wars. As an Internet-only retailer, Amazon almost never has to collect sales taxes, so it almost automatically underprices its competition. Sears (Nasdaq: SHLD) Chairman Eddie Lampert is crying foul (loudly and often). Netflix (Nasdaq: NFLX) CEO Reed Hastings says Amazon's suggestion that it's too hard to collect sales tax is silly. ("It's not very hard.") For that matter, Amazon itself seems to have no problem collecting tax on online sales that it manages for the Target (NYSE: TGT) storefront that it runs (although not for much longer).

Seems the only time Amazon runs into difficulty collecting tax is when it has a vested interest in making a sale of its own.

Where there's smokescreens, there's fire
Call me a cynic, but Amazon's objections to the collection of sales tax online ring false to me -- but not just me. Across the country, states from Texas to New York are suing Amazon in court to force it to collect sales taxes. So far, Amazon has dodged the bullets, but I don't believe it can keep up this dance much longer. Sooner or later, Amazon's going to lose a big court case -- or at the very least, investors are going to recognize the risk that it will.

Personally, I think 2011 is the year it happens. This will be the year that Amazon finally gets its comeuppance -- and, for its stock price, a major come-down-ance.