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Amazon is overvalued, and that's OK


Shares of Amazon (AMZN) are got clobbered Friday after the company reported fourth quarter sales of $25.59 billion and net income of $239 million, or 51-cents per share. For the year Amazon had revenue of $74.5 billion, a 21% gain over last year. The company was cautious on outlook for revenue and earnings for the current period. On the conference call Amazon said it was considering hiking the annual price of its Amazon Prime service by anywhere from $20 to $40 from the current $79.

Wall Street was less than impressed as the company failed to meet expectations for the third straight quarter. The stock opened down more than 5% and continued to slide throughout the day.

It was a landmark quarter in the sense that the revenues are likely high enough to push Amazon past discounter Target on the list of the top U.S. retailers ranked by revenue. Assuming Target doesn’t beat estimates next month, Amazon will be the sixth largest merchant for 2013, behind WalMart (WMT), Costco (COST), CVS (CVS), Kroger (KR), and Home Depot (HD).

The rap on Amazon’s stock is that it’s wildly expensive compared to other big retailers. While there are theoretical efficiencies in running an online retailer compared to cost-intensive operations like discounters or grocers, a great deal of goodwill on future profits is already priced into the stock. The bear case is that Amazon would have made money by now if it could.



The comparison is bogus and it’s silly to think Amazon can’t make money. The margins for a mature grocer or discounter are horrible. On a net income basis Target makes about 3.5% and a Kroger nets less than 2%. Neither Target nor Kroger has any revenue growth to speak of though both certainly try.

Amazon has about 20-million Prime customers and the base is growing at 20-30% per year. If Amazon raised prices by $40 and never signed another customer up for Prime again it would bank roughly $500 million in additional profit. Amazon is tweaking profitability dials with Prime, not trying to create new business. It’s a good problem.

Compare that to Target with no realistic U.S. growth opportunities and huge headaches internationally. Target is falling apart in Canada. If a U.S. merchant based in Minnesota can’t grow in Canada, it can’t grow anywhere.

Nearly 20 years after going public Amazon is still almost impossible to value on an objective basis. Amazon shares are an inkblot test. When the market feels optimistic it pushes the stock higher. On days when it seems the sky is falling, bears hammer Amazon and carp about the fundamentals.

Amazon is a growth company in a capital-intensive business. It’s always been overvalued and likely always will be as long as Jeff Bezos is there. When Amazon says it’s done driving the top line and is going to focus on pushing net margins to the mid-single digits and buying back stock it’ll be a great short. Until then it’s best not to lump it into any category or sector. Amazon is just Amazon… It’s a whole different animal.