Amazon is Overvalued and on the Wane: Part II
Larry is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In my last post, on Amazon (NASDAQ: AMZN), whose stock recently rallied on the back of a positive earnings surprise, I discussed some of the myths circulating to justify the stock's nosebleed valuation (185 times trailing earnings).
The online retailer does not deserve that multiple, and does not have a bright future. Here in Part II, we'll look at some facts about the company and crunch some numbers.
Truths about Amazon
Amazon is a retailer.
It is not a cool product company like Apple (or even Gillette), and it is not a cloud stock, Amazon Web Services (AWS) notwithstanding. It is a retailer of general merchandise, the biggest general store out there. A more accurate comparison is Wal-Mart Stores (NYSE: WMT), the behemoth retailer whose sales are still 10 times Amazon's. Wal-Mart annihilated the regional and local department store model, taking a lot of local general merchandise business with it in the process. Like Amazon, it used economy of scale, friendly service and significant price advantage to become dominant.
But the Wal-Mart tree didn't grow to the sky. Instead, the stock price peaked at the end of 1999 and has been dead money ever since (though with the dividend, you did get some return). The law of large numbers caught up with the company: It doubled sales from 1995 to 1999, but the last doubling took almost 10 years. Once it owned the general merchandise business, it became stuck with rates of growth tied to the growth in the gross domestic product. Specialty retailers – like Apple, Lululemon and most of the luxury category – don't and won't distribute their products through Amazon or Wal-Mart.
Amazon's margins will always be supermarket margins.
If there is one issue that can start a fight in the Amazon tavern, it's the question of profits. Does one use a figure based upon Generally Accepted Accounting Principals (GAAP), or use some non-GAAP variation? Companies frequently like to report “Adjusted” earnings (which used to be known as "EBBS," or "Earnings Before Bad Stuff") that omits unpleasantries like stock compensation or write-offs.
Let's cut to the metal and look at what we consider two very important metrics, ones that are much harder to fool with over time. The first is shareholder equity. Now, this number isn't impervious to accounting tricks, and we could have a lively discussion about Amazon's goodwill, but we don't need to at this moment.
Consider the annual growth rate in Amazon’s shareholder equity (SE) since 2006:
2011 2010 2009 2008 2007 2006
|
SE |
7,757 |
6,864 |
5,257 |
2,672 |
1,197 |
431 |
|
chg |
13.01% |
30.57% |
96.74% |
123.22% |
177.73% |
75.20% |
Note how it has steadily fallen off, to a rather pedestrian 13% in 2011 (and 6.4% for the twelve months ending March 31st, 2012).
We're going to combine this with our own measure of cash return on the business: cash from operations, excluding changes in working capital, and after capital expenditures. In other words, how much are you really earning from your business operations? I use it as my "real" operating margin.
Using this measure, Amazon's average annual operating margin going back to 2003 (we excluded the recession year of 2002, in order to have a reasonable base) is 3.6%. It peaked in 2003 at 5.5%, and bottomed last year at 1.3%, but we don't necessarily take last year as the final indicator. The measure fluctuates, yet suggests that the median rate over the same time period is 3.4%. In the first quarter of 2012, the rate was 3.6%.
This is a supermarket margin. Not the bottom of the pack, certainly, at 1% or 2%, but a supermarket number all the same. And 3.6% is no growth tech number, or even much of a tech number at all: our 2011 estimates for this measure in three other companies that we follow, cloud-computing software maker VMWare (NYSE: VMW), cloud-based client management software provider Salesforce.com (NYSE: CRM) and chip maker RF Micro Devices (NASDAQ: RFMD), range from 15% to 25%. Amazon earned $1.36 per share in cash after cap-ex for 2011, giving it a pricey multiple of 135 times to 150 times, based on the recent trading range (VMWare and Salesforce.com are both in the 60-times range).
M. Kevin Flynn, CFA, is the president of Avalon Asset Management Company in Lexington, Mass.
This post was written by M. Kevin Flynn and edited by Larry Light, editor-in-chief of AdviceIQ. Niether owns shares of any of the companies mentioned. The Motley Fool owns shares of Amazon.com and has the following options: short JAN 2013 $150.00 calls on Salesforce.com and long JAN 2013 $150.00 puts on Salesforce.com. Motley Fool newsletter services recommend Amazon.com, Salesforce.com, and VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
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