Breaking news alert: Amazon.com (NASDAQ:AMZN) is overvalued!
Last week’s positive earnings report — and associated gain of 18%-plus (and counting) in the stock price — has unleashed a new wave of carping about the Internet retailer’s valuation. And the numbers truly are amazing: Amazon checks in with a trailing P/E of 168, a forward P/E of 87, and a PEG at a stratospheric 6.8.
This didn’t deter analysts from boosting their targets: Goldman Sachs raised its target to $300 — a full 30% above Amazon’s current level — while Nomura and Merrill Lynch see the stock moving to $285 and $270, respectively.
This obscures the fact that Amazon beat sharply reduced earnings estimates, and — strong top-line growth aside — that estimates have been trending lower in recent months. Current 2012 estimates, at $1.27, have dropped considerably from $1.88 ninety days ago. Also seemingly lost in the rally is the role investment gains played in the earnings beat, as well as the potential impact of state sales taxes on the company’s future competitiveness.
Amazon remains a mystery to those who seek to value the stock based on fundamental analysis alone. The Internet bubble came and went, and the companies that survived largely trade with reasonable multiples, such as Google (NASDAQ:GOOG) at 12.1 times forward earnings, or even recently scorching eBay (NASDAQ:EBAY) at 15.2. Bulls would cite Amazon’s outstanding prospects as a reason to pay up for the stock, but consider this: If Amazon generates 20% annual earnings growth for the next decade off of the consensus 2012 estimate of $1.27, the stock still would trade at 29.3 times earnings in 2022 — even if its price didn’t budge from its current level near $230. This indicates that the likelihood of Amazon mirroring Wal-Mart’s (NYSE:WMT) feat — growing into its valuation by trading sideways for many years — is unlikely.
Put this all together and you have the recipe for an easy short, right?
Actually, history indicates otherwise. Consider this Barron’s cover story from 2003 that panned Amazon on the basis of its valuation. The stock slipped a little more than 6% in subsequent days, then recovered and never looked back: By Nov. 3, it had gained 120% from the Friday before the article hit.
Nine years later, the lesson remains the same: Trying to short Amazon on the basis of valuation alone is not an effective strategy. Every article citing the stock’s unreal valuation might be correct, but making money on a short is a question of timing. And until evidence shows us otherwise, the prudent course is to assume that Amazon is going to remain overvalued indefinitely.
Otherwise, betting against Amazon can be a recipe for disaster: In just the past year alone, there have been eight different occasions in which Amazon has experienced rallies of more than 10% in 12 or fewer sessions. And in all of this time, the trailing P/E never dropped below 75. How much more evidence do investors need that it’s dangerous to judge this stock on the basis of traditional valuation metrics?
Yes, Amazon is overvalued. But it has been overvalued since Bill Clinton was in office and Michael Jordan still was with the Bulls. Someday Amazon’s valuation will catch up with its performance, but for now the conventional wisdom about a bubble firmly applies: Don’t buy into it and certainly don’t try to short it. Just watch from the sidelines and enjoy the show.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.