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Sunday, December 13, 2009

Barron's Calls Out Amazon - Cites Perils of High Valuation

On 10/23/09, we noted that Amazon (AMZN, $134.15) was a powerful franchise with impressive growth, free cash flow, and returns on capital. Yet, we also said that the stock, then at $93.45 with an implied TTM free cash flow yield of 4.7%, was in a fair value range and expensive for our liking. With shares up 44% (versus S&P 500 up only 1%), we find the valuation even less attractive and prone to disappointment (no margin of safety).

Still, the Market includes all kinds of participants, including a large number of momentum traders who keep buying or selling something because "it works". For example, on 12/2/09, Cramer discussed a momentum based valuation approach (i.e. apply a P/E of two times estimated earnings growth of 30%, or 60 times next year's estimated earnings) to derive a $216 target price with a view that current consensus estimates are 20% too low.

We think his analysis probably is inline with that of some momentum based investment funds and some sell-side analysts. News of favorable E-Commerce trends further feeds momentum. Meanwhile, more "shorts" who keep saying the valuation is insane and isn't sustainable, cover positions as patience runs out and short-term unrealized losses increase (dangers of a valuation-based short thesis).

Barron's has a feature story this weekend on Amazon that highlights risks and includes interesting tables. The article draws a parallel to Wal-Mart (WMT, $54.65):
  • Wal-Mart Stores, the archetypal discounter, was the retail growth story of the 1990s. As that decade ended, its shares traded at 69, or for 57 times its 1999 profit of $1.20. Since then, Wal-Mart has slid to 54, even though its earnings have tripled and revenue has more than doubled. The Wal-Mart experience shows that investors can lose money in the shares of a great company if they pay too much.
Also from the story, comparing Amazon to Walmart and Target (TGT, $46.93):

While Amazon benefits from an asset-light business model, we concur that the recent run prices in significant future growth. As valuation multiples further expand, the probability of disappointment increases. We retain a preference for online retailers such as eBay (EBAY, $22.70) and PetMed Express (PETS, $17.85), as well as the completely unloved Bidz (BIDZ, $2.28). We submit that the probability of the share price for any of these companies doubling before that of Amazon is quite high.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long EBAY, PETS, BIDZ.
© 2009 Jeffrey Walkenhorst
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