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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Saturday, July 7, 2007 (Nasdaq:AMZN)- Not Worth the Price

Trading near $70 per share at the end of the first week in July, Amazon appears overvalued. The price is very steep considering its volatile past and its razor thin profit margins. One thing AMZN has delivered is top line growth. Sales have been increasing at a very robust rate, yet very little falls to the bottom line. This means little cash is left to distribute to shareholders.

Even though Amazon retains all income to plow back into growth, stocks are valued on the premise of CF that could be distributed if the company so chose. Revenue has grown an average 28% annually the past 5 years, yet operating margins have average just a little more than 4% and net margins less than 2%.

Currently AMZN trades at 68x this years estimated earnings and 52x next year. Google trades 32x next year’s eps and Ebay trades at 24x. Both have Similar growth prospects as Amazon, but their margins are extremely higher and they also don’t have to invest in physical inventory such as AMZN.

No matter how fast Amazon expands, the fact is profitability will remain weak due to intense competition endemic to the retail industry. Amazon has to offer low prices to bring consumers to cyberspace as opposed to the bricks and mortar outlets. Prices also have to be low enough to offset the cost of shipping. Many large bricks and mortar companies are becoming more savvy with creating and managing their online stores. As they continue to improve, Consumers can shop online and possibly have the option to pick the items up from a physical store if one exists nearby.

Amazon is working on providing more web-based services and downloadable media products but competition looms there as well. In that aspect, Amazon is up against the likes of Google, Ebay, and Yahoo, all of whom have been in the game much longer. Additionally, AMZN has had to spend heavily on research and development in those endeavors essentially offsetting much of the benefits it provides. Amazon's share price has nearly doubled since April on the heels of improved earnings and outlook.

Some of theEPS improvement can be attributed to an artificially low tax-rate due to loss-carryovers, favorable forex translation, and cutbacks in R&D. So, the question is: are those conditions sustainable in the long-run?

3 years ago AMZN earned $1.39 / share with the aid of a negative tax rate and a lower R&D spending the next two years EPS declined to $.78 then to $.45. This year’s EPS is expected to be up @ $1.02 but with rates rising and a tired consumer, sustaining EPS growth will still be difficult even if AMZN has additional help with low tax rates and forex gains.

Revenues have to continue their rapid pace for a substantial length of time and margins have to expand in order to justify the current price. At AMZN’s current level, the required rate of return is too low given the involved risks. Amazon has to meet very high expectations just to keep to stock where it is now, eliminating upside potential and creating huge downside risks.

Many of Amazon’s peers trade at lower multiples and they are better performers. That’s contrary to fundamental logic of paying up for higher returns. It doesn’t make sense to pay more and get less.

A more realistic valuation in my opinion is $45/Share. I definitely believe the stock has gotten ahead of itself, and short covering has definitely helped push the stock higher as 8 million shares of short interest got squeezed out last month.

I wouldn’t bet against this price momentum either; I wouldn’t short it unless the technicals completely collapsed. I wouldn’t buy it either unless it dropped into the low 40’s.


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