The market's rocking, and new tech is leading the way.
Amazon.com (Nasdaq: AMZN) has made the most
of the rally, more than doubling since bottoming out 11
months ago.
Has the leading online retailer earned these heady gains?
Its rich valuation multiples appear to leave little room for
error. But is there more to the Amazon story than a high P/E
ratio? What are the downsides and upsides for investors at
this point?
Every investor -- or potential investor -- needs to ask
these questions.
The bearish case
As we barrel toward Thursday night's quarterly earnings
report, consider Amazon's recent challenges:
a price warwith
Wal-Mart (NYSE: WMT) five days ago, with
some of the hottest hardcover preorders dropping to just $9
a copy. There are even a few cases in which Amazon is
selling the hardcover for less than its digital Kindle
version.
Speaking of Kindle,
Barnes & Noble (NYSE: BKS) is set to
introduce
its new e-book readertomorrow, giving Amazon's Kindle
one more rival to worry about. Barnes & Noble is late
to the game, but it serves the ideal audience of
booklovers.
One of Amazon's pricing advantages is that it doesn't
have to collect sales tax in states where it doesn't have a
physical presence. Many states in budgetary crunches are
legislating an endto that.
There is also the matter of the company's valuation.
Amazon may be blessed to be growing -- and gaining market
share -- in this recession, but it has replaced its running
shoes with concrete boots. Earnings and revenue are projected
to rise 13% and 18%, respectively, this year. These are
applause-worthy forward steps in this crummy economic
climate, but the earnings multiples are steep. Amazon is
fetching a lofty 56 times this year's projected profitability
(and a still nosebleed-inducing 44 times next year's
bottom-line target).
The valuations are certainly rich. Unlike other dot-com
stars, Amazon is still a retailer at heart. It has tangible
goods to sell, ship, and receive in occasional returns. Its
net profit margins have historically been in the low single
digits.
The bullish case
Longs will argue that Amazon's business is better
measured by
free cash
flowthan earnings. The company is a money machine. At
many public companies, profits can exceed the actual net
inflow of greenbacks, but Amazon works the other way around.
Free cash flow over the past year clocks in at a healthy $1.5
billion, or
more than double its profitability. Amazon is trading at
a more reasonable 27 times trailing free cash flow, a figure
that has improved by 89% over the past year.
Margins may also improve, though investors need to be
realistic. Even high-end luxury retailer
Blue Nile (Nasdaq: NILE) is cursed with 3%-4%
net margins -- that's the fruit of selling big-ticket
jewelry. Amazon, at least, has a real opportunity to expand
margins through the company's digital downloading initiative.
The e-tailer is now selling movies, music, books, and even
video games in digital form. Protective content creators and
cutthroat online rivals will keep markups honest for now, but
the future should be more promising.
After all, it's a lot easier to run a business when you
don't have to worry about keeping inventory, subsidizing
fulfillment costs, and fretting over returns.
Amazon's still rocking with tangible merchandise, too. It
continues to take big bites of market share, thanks to its
double-digit growth during a year in which analysts are
projecting flat sales at Wal-Mart,
Target (NYSE: TGT), and online rivals
including
Overstock.com (Nasdaq: OSTK) and Blue
Nile.
The moment of truth
I can't dismiss my concerns. A price war heading into
the holidays will pinch the already lean margins. If $9
hardcover new releases become the new promotional standard,
the lower price might quash the e-book revolution that
Amazon's Kindle is championing. Continued... |