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Amazon Stock Biting Off More Than It Can Chew?

Companies / Internet Sep 09, 2014 - 03:15 PM GMT

By: Investment_U


Zachary Scheidt writes: (Nasdaq: AMZN) is one of the best growth stocks of our generation. Over the last 10 years alone, revenues have grown from $6.3 billion to more than $80 billion per year. Yet despite all the revenue, profits have been absent.

Jeff Bezos, the company’s founder and CEO, built his empire by growing revenues with the promise of profits. His strategy has been to aggressively cut prices (at the expense of profits) to gain market share. Thus far, the strategy has made the company into a retail powerhouse. Bezos hopes to repeat this success with the company’s new business lines.

And investors believe in Bezos and his visions of future profits. Today, Amazon trades above $340 per share despite earning only $0.64 per share for the past year. This puts Amazon at a high valuation of more than five times earnings.

Faith in Bezos’ no-profit growth strategy may be put to the test soon. The company reported a second quarter loss of $0.09 per share. More importantly, management warned that the third quarter will be even more challenging. As Amazon invests in new business lines, short-term losses will grow. Analysts currently expect Amazon to lose $0.75 in the third quarter.

What is to blame for these expected losses? The company has a handful of ambitious projects it is currently rolling out.

First is Amazon Web Services (otherwise known as AWS). With this division, Amazon offers cloud computing services to individual businesses. Unfortunately, there is already fierce competition in this industry and these services are fast becoming a commodity. As prices drop for cloud computing, potential profit for Amazon declines.

Amazon is also trying to break into the digital content media business including both film and music mediums. Again, this is an extremely competitive industry. Apple (Nasdaq: AAPL) dominates the landscape for music, while established film producers hold down the video industry.

Finally, Amazon has introduced a new smartphone to the market, the Amazon Fire Phone. While bulls cheer this move as a progressive step, skeptics wonder whether Amazon is late to the game. Will this new phone be able to take business from Apple and Samsung?

Investors worry that these new business lines may derail the company’s progress toward meaningful profits. Under the very best-case scenario, these projects will delay a payoff from Amazon’s retail success. And if one or more of these ventures fail, losses will add up quickly.

Following the company’s disappointing earnings announcement, shares dropped by more than 10%. And yet Amazon is still trading at more than 200 times expected earnings. Investors are only now beginning to wise up to the risk embedded in Amazon’s valuation.

If all goes according to plan for Amazon, analysts expect the company to earn $1.94 per share in 2015. Even if these assumptions are correct, Amazon is still trading at a silly triple-digit price/earnings multiple. Shares could easily drop by 50% or more and still be priced optimistically.

If Amazon does NOT live up to expectations, things could get ugly quickly. Investors have had to wait a long time for the company to start producing profits from its growing revenue stream. If these investors are told they need to wait again, while the new business lines mature, all hell could break loose.

Amazon’s premium valuation makes the stock vulnerable. And the recent gap following the earnings announcement shows that investors are losing patience with the company. Long-time investors in Amazon with unrealized profits should continue taking some gains off the table. And aggressive traders may want to consider a bet on falling prices into year-end.


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