Five Reasons to Stay Away from Amazon

Written by Jake Mann, WealthLift Finance Editor in Featured, Stock Analysis | 2 comments

As the most successful online retailer in the world, Amazon.com (AMZN) is a darling of many money managers, as it is currently held by over 2,500 mutual funds and 40 hedge funds.  For more on the latter, see WealthLift’s educational series on hedge fund strategies.  In recent months, shares of AMZN have been very kind to investors’ pockets, having returned a cool 23.5 percent since the start of 2012.  In fact, the stock is currently trading around $220 a share, near its all-time high of $246.71, which was reached last year.  This appreciation has been driven by strong top line growth, as the company’s revenues have doubled in the past two years; they were over $48 billion in 2011.  Despite this success, there are a few reasons – five of them to be exact – that investors should approach Amazon with caution if they are looking to buy in now.

1. Amazon is valued like a tech company even though it is a retailer.  In 2011, 60 percent of the company’s revenues came from sales of electronics and other merchandise that is not unique to Amazon.  In other words, there is nothing that distinguishes these products from those at other retailers like Best Buy (BBY), eBay (EBAY), and even Wal-Mart (WMT).  Moreover, another 37 percent of sales were from eBooks, and while this industry is growing extremely quickly, books are one of the least differentiable products out there from a retail standpoint, as they have been throughout most of human history.  This leaves only 3 percent of Amazon’s sales that are truly derived from any tech-based business – its cloud-computing services known simply as ‘Amazon Web Services’.  While AWS is the company’s most profitable business area, 3 percent is simply too small to call Amazon a true tech company.  The markets, however, are confusing the two, as shares of AMZN are currently trading at a Forward P/E – a financial ratio measuring how investors value future earnings – of 84.2 times earnings.  This is closer to that of the IT industry’s average (38.0X) than the retail industry’s average (14.7X).

2. The Kindle’s days as the dominant e-reader are numbered.  As of the first quarter of 2012, Amazon’s Kindle Fire had captured 14 percent of the overall tablet market, compared to the iPad’s 51 percent.  When looked at next to the company’s original Kindle line, which holds 67 percent of the e-reader market, this is not an underachievement as much as it represents the truth – Apple (AAPL) will beat Amazon in a heads-up hardware contest almost every time.  The only advantage the company has over Apple is its cheaper price points, which will be a thing of the past by the end of this year.  Once Apple enters the e-reader competition with a lower priced iPad mini, it is likely that Amazon’s market share will dwindle.

3. Earnings and cash flows are wilting.  Despite Amazon’s quick revenue growth, the company has had trouble translating this into a strong financial position, as earnings per share and cash flows actually shrunk last year.  Specifically, EPS declined by 45 percent and free cash flow – the best measure of a company’s cash hoard – fell by 20 percent.  Because of these declines, it does not make sense why investors are overvaluing both of these measures; P/E and P/CF ratios are both sky-high and above industry averages. 

4. Higher taxes are on the horizon.  In the U.S., 45 states levy a sales tax on their residents, though Amazon only collects this tax in 5 of these states.  Unlike most developed countries in the world, there is currently no federal sales tax, hence the reason that this online retailer is able to skirt the rules.  This gives Amazon a decided advantage over its traditional ‘brick and mortar’ competitors, as most American customers would prefer to avoid a tax.  In an effort to protect retailers that are facing this hindrance, there is currently legislation in Congress that would allow states to employ a so-called ‘Amazon tax’.  With most levels of government looking to trim their budget deficits, this would be an easy source of revenue.

5. Amazon has no competitive edge in the cloud-computing arena.  As mentioned above, ‘Amazon Web Services’ is a cloud-computing service that the company claims is its most profitable venture, though they won’t release the official data.  Either way, Amazon got into this arena earlier than most – 2002 in fact – but this still only makes up a fraction of its business.  While the future is bright, there is now a range of competitors that offer the same service as AWS, many of which are more adored by cloud-loving consumers.  Whether it is SugarSync’s superior security encryption, or JustCloud’s easier-to-use mobile features, there are many alternatives to Amazon; it is not justifiable why bulls are thinking otherwise.

All in all, it may be best for investors to wait to buy shares of AMZN until they fall to a more attractive valuation, or until the company can translate revenue growth to its bottom line.  One certainty, however, is that the bearish truths described above are not going to disappear anytime soon.

Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours.  He does, however, have the intention of rating these stocks on WealthLift.com, a social media website where investment ideas are shared openly and free.

Jake Mann is a Finance Editor at WealthLift.com, pursuing a double major in Economics and Business Administration at Illinois Wesleyan University in Bloomington, IL. In his spare time, Jake enjoys playing guitar, serving as Editor-in-Chief of the Undergraduate Economic Review, and being an active member of Tau Kappa Epsilon.

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