U.S. Markets close in 1 hr 19 mins

A Looming Market Cap Milestone Could Spell Disaster for Amazon Stock

Will Healy

Amazon.com, Inc. (NASDAQ:AMZN) has seen a recent decline. Worries in the overall market and the latest round of failures related to Amazon Fresh have weighed on the stock. Amazon stock can recover from its recent $100+ per share drop.

However, given its valuation, any significant decline in the stock price can leave investors asking if this is the point where the Amazon bull market ends.

Assuming the rally continues, the stock is coming up on one unexpected milestone that could trigger its decline—achieving the world’s largest market cap.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Lofty Valuations and Amazon Stock

As frequently as I have criticized Amazon in previous articles, I have to admire its vision. Amazon’s first-mover status built as much of a moat as one could expect from an ecommerce business.

They also took over a business that would have belonged to Sears (NASDAQ:SHLD) or Walmart (NYSE:WMT) had either company exhibited a grander vision.

Amazon’s success in ecommerce made it into the most feared and admired company in retail. Further, Jeff Bezos’ vision of cloud computing has provided them not only dominance in a non-core business, but also a source for the majority of their profits.

However, this visionary leadership and its massive revenue and profit growth have taken its valuation to dangerous highs.

Though Amazon stock has come down in recent days, its price still places its price-to-earnings (PE) ratio at about 240. Its PE stands at 135 on a forward basis.

Despite its overall movement higher, valuation matters at some point. At its current PE, the market has priced Amazon stock for perfection, yet the signs of imperfection continue to appear.

Complaints regarding and poor working conditions have dogged the company for years. Also, the failures of Amazon Fresh have punched further holes into the “Amazon will take over the world” narrative.

Retail stocks such as Target Corporation (NYSE:TGT) and Costco Wholesale Corporation (NASDAQ:COST), once hurt by this perception, now trade at much higher levels than they saw one year ago.

The Market Cap and Amazon Stock

Also, as much as I have discussed historical parallels to both Walmart and Sears, Amazon could face a daunting headwind from an unexpected source—its market cap.

Amazon has achieved the world’s second-largest market cap behind Apple (NASDAQ:AAPL). However, such an achievement shows similarities to another high-PE stock that briefly attained the title of world’s largest market cap—Cisco Systems (NASDAQ:CSCO).

By the end of the 1990s tech boom, Cisco had become one of the most admired companies in the world. As a result, investors bid the stock’s value higher.

Cisco’s size and profit levels remained a small fraction of the market cap leader at that time, General Electric Company (NYSE:GE). Despite the size differential, Cisco’s market cap overtook that of GE for a brief time.

However, that moment appeared to serve as the high-water mark of CSCO. Soon after Cisco achieved the world’s largest market cap, the tech boom ended.

CSCO stock fell from $82 per share to below $15 per share within a 12-month time span. It would drop into the single digits before rebounding in subsequent years.

CSCO stock maintained a PE in the teens for most of the time since, though its current PE has risen to 23. However, despite its solid performance, CSCO stock currently trades about 50% below its 2000 high.

One has to wonder if such an achievement would spell the end of the bull market in Amazon stock. If Amazon were to repeat CSCO’s performance during the tech bust, the stock could fall below the $300 per share level.

I realize most who this believe that such an occurrence is unthinkable. Admittedly, reading about past stock crashes usually fails to deliver an emotional impact.

However, history shows that such a crash can happen. Do not expect an exemption for Amazon stock in such a scenario.

The Bottom Line on Amazon Stock

Achieving the world’s largest market cap could spell the end of the bull market in Amazon. Despite recent problems with execution, Amazon continues to thrive on its visionary leadership decisions and massive profit growth.

Still, grand visions carry only so much value. At a current PE of nearly 240, this vision could hit its limits, especially when the current market cap leader Apple earns about 16 times as much income.

Amazon will likely exert market leadership over both retail and cloud computing for years to come. However, investors should not expect that influence to keep AMZN stock at its lofty valuation.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

More From InvestorPlace

Compare Brokers

The post A Looming Market Cap Milestone Could Spell Disaster for Amazon Stock appeared first on InvestorPlace.