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, (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.
  • (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.