Amazon.com, Inc. (NASDAQ:AMZN), the well-known online retailer, has befuddled value investors for a while. These investors have been waiting for its shares to decline from what is believed to be an extremely enthusiastic price level, but this stock, which recently reached an all-time high, just refuses to comply.
Though the stock seems to have Teflon-like backing, there may be a way to short Amazon successfully. Anticipating the right inflection point, or the time when its support begins to turn, could greatly increase one’s chances. That inflection point will likely be when the positive factors buttressing the stock are no longer compelling enough to offset its negative attributes. But what are these factors currently supporting the stock?
Amazon’s bullish argument
There are legitimate reasons Amazon.com, Inc. (NASDAQ:AMZN) should sell for a premium price. The company might be the best operator in the retail space. It offers incredibly convenient access, maybe the widest-range of in-stock product, and extremely competitive pricing. To prove its retail powerhouse status, Amazon has shown an incredible record of revenue growth. The company has more than tripled its sales from 2008 to 2012, and posted an amazing 78% revenue jump over the last two years.
Another supporting factor is the expectation that Amazon will significantly increase its profitability. Though revenue has grown steadily, reported profits have been haphazard. The company posted net income of $645 million in 2008, peaking at $1.15 billion in 2010, and then dropping to a slight loss of $39 million in 2012. This inconsistency, though unsettling, has not dampened investor enthusiasm. Sustaining the stock is Wall Street’s assumption that the company will eventually deliver consistent profits. There is some historical evidence supporting that belief, with Amazon.com, Inc. (NASDAQ:AMZN) generating profit margins between 3.3% and 3.6% from 2007 through 2009.
It seems that the combination of impressive revenue growth and the expectation of meaningful profit are the key factors backing Amazon’s share price.
Amazon’s bearish argument
On the other hand, the short thesis seems to rest on the company’s lofty valuation, or adjusted cash earnings multiplied by a market capitalization factor. Based on its 2012 financials showing $61.1 billion in revenue and adjusted cash earnings of $1.56 billion, Amazon sells at a roughly 79x multiple. Using enterprise value, or stock market value plus debt, relative to revenue as a secondary valuation technique, the company is valued at around 2 times sales. These valuations can be compared to its major retailing peers: Costco Wholesale Corporation (NASDAQ:COST) and Wal-Mart Stores, Inc. (NYSE:WMT).
Costco operates membership warehouses, offering very low prices on a limited selection of nationally branded and select private-label products, in a wide range of merchandise categories. The company excels at producing high sales volumes and rapid inventory turnover, and has shown revenue growth of around 27% from 2010 through 2012 with profit increasing 33%.
Given its history of revenue and profit growth, Costco likely deserves a higher than average multiplier. The company currently sports a multiple of 18x to 19x based on analysts’ expected revenue of $107 billion, and anticipated earnings of $2.32 billion at a profit margin of around 2.2%. On a secondary valuation basis, its enterprise value calculates to around 0.42 times sales.
Wal-Mart is a very familiar retailer with more than 10,000 stores in 27 countries. It is a consistent cash earner with a track record of buying back shares, and offers a good dividend with a current yield of around 2.6%.
The company has shown solid revenue growth of roughly 11% from 2010 through 2012, with net income increasing 22%. Given its performance, offset by some potential legal issues from Mexican operations, Wal-Mart probably should trade at the slightly discounted 11x to 12x multiple based on analysts’ projected revenue of $492 billion and adjusted earnings of $21.1 billion with a profit margin of around 4.3%. Its current enterprise value is roughly 0.59 times sales.
Relative to its peers, Amazon’s value does look stretched. One might reasonably assume that any decline in market sentiment would probably pull the shares significantly lower. A less sanguine value could be based on estimated revenues of $81 billion and an earnings margin of 4.5%, or $3.65 billion. Using a premium 20x multiple, reasonable value looks to be around $161 a share. A more exuberant 25x multiple fair value comes in around $201 a share. Assuming an enterprise value at 1.0 times sales, $174 per share looks plausible.
Conclusion
Pinpointing the key inflection point that realizes these lower prices might hinge on two factors, a revenue lag and a consistent earnings record. As long as revenue growth tops 20% a year and Wall Street anticipates commensurate profit gains, there is little reason to believe confidence in the stock will wane. Though market conviction will be tested once a noticeable slowdown in sales growth has been demonstrated, it is when Amazon’s long-term profitability can be quantitatively calculated that might pose the biggest risk to sentiment.
As the expectation of profits are priced out of the market and consistent results are priced in, optimistic hope will eventually have to be confirmed by mathematical reason. It is typically at this point where cold fact rather than prospective belief more accurately determines market value.
Successfully shorting Amazon.com, Inc. (NASDAQ:AMZN) might not be a question of “if” but more of “when”. The company’s overly enthusiastic valuation seems to hinge on a couple of key supports. Though looking unassailable now, once those supports are weakened, a meaningful share price drop might finally be seen.
The article Can Amazon Be Successfully Shorted? originally appeared on Fool.com.
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