Are Amazon Investors' Hopes Riding on Hype?

John-Erik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Retail e-commerce, or e-tail, is a megatrend in full swing. Investors should be considering ways to capitalize on it.

At a time where overall U.S. consumer spending has crept along at an average annual growth rate of under 2%, e-commerce has been growing by leaps and bounds. E-tail sales were up by 15% in 2012. And that held true to a sustained trend. Year-over-year growth in online commerce has been in the double digits in each quarter since mid-2010, according to comScore.

What’s more, the trend looks to be accelerating out of the recession. There appears to be plenty of opportunity for investors to cash in, so I’d like to devote a few posts to the potential winners and losers in this e-tail megatrend.

Let’s get it right out there. The company you just can't ignore in this sector is Amazon (NASDAQ: AMZN). It  has been on an absolute tear, gobbling up market share every step of the way. Amazon has grown its annual revenues by some 314% since 2008. Amazon’s growing popularity and ever-expanding offerings are pummeling brick-and-mortar stores across the U.S.

Disrupting retail

Best Buy (NYSE: BBY) is among the victims. As Amazon posted sales increases of 40.6% from 2010 to 2011 and 27% from 2011 to 2012, Best Buy’s sales grew by less than 1% per year. What’s more, Best Buy has been hurt by the phenomenon of “showrooming.” It’s when customers visit a physical store, have a look at a product, even test it out, only to return home and order it from Amazon or another e-tailer that’s selling it cheaper and shipping it fast.

Best Buy promised a push for the Christmas quarter in 2012, vowing to match prices and ship for free. We’ll find out if it had much success later this month. Best Buy reports on Feb. 28.

The electronics seller is far from the only traditional retailer feeling the Amazon squeeze. Target (NYSE: TGT) last month unveiled a plan to match prices of the e-tail king, hoping to stem customer showrooming and retain business. Consider that in 2009, Amazon executed less than one-third of Target’s $64 billion sales that year. Yet in 2013, Amazon is expected to eclipse Target’s estimated $73 billion in revenue. It's easy to see why Target has needed to take action.

Even Wal-Mart (NYSE: WMT), the undisputed king of American retail, has taken some measures to fight off Amazon. Last fall, Wal-Mart announced plans to offer same-day shipping in some markets, a move that coincides with Amazon’s strong push to get goods to customers faster. For Wal-Mart, the move seems more proactive, since the retail giant has been able to keep growing – revenues were up almost 10% between early 2010 and early 2012 – despite having more than 9,000 stores around the globe. But still, the fact that it’s making the moves in response to Amazon’s growing market share speaks volumes of just how disruptive Jeff Bezos’ company has been in the retail world.

No slam dunk

It’s a pretty compelling story for Amazon, a company that not too long ago was a mere online bookseller. With rocket-like growth, great name recognition and competitors on their heels, Amazon looks like a lock to capitalize on the e-tail trend, right?

Well, maybe not. There’s no question Amazon has been great for its customers. And there's no question that it's one of the most alluring business stories of this generation. But as an investment, there are still some significant areas of concern for this fast-growing company.

The first of those is valuation. Investors sometimes say a stock is priced to perfection, meaning that any miss in earnings or revenue will be sure to send the stock in a tailspin. Well, Amazon is priced beyond perfection. It is untethered to any fundamental valuation. When it missed expectations last month, its shares rose. It seems to defy logic, and while Amazon investors are not complaining, its lofty valuation leaves it prone to a potential freefall.

The second key reason for concern is Amazon’s push to get more products to customers faster – and the costs that will come with it. A big reason Amazon lost money in previous quarters is that it has been investing in itself, building out its network of warehouses, or “fulfillment centers.” This is key to the company’s strategy to offer a continually wider array of products and deliver them to customers faster. It now operates more than 30 fulfillment centers in the U.S. alone, and plans to open several more over the next two years.

This seems like a wise investment from a customer satisfaction standpoint, Amazon’s real strength. But the effect on Amazon’s cost structure could be significant. Those warehouses are not one-time expenditures. They are ongoing costs. I’ll direct you to a post by fellow Fool blogger Chad Henage, who explored Amazon’s growing headcount in this piece, and argued that Amazon is becoming more and more like a traditional retailer.

Let me sell you a story

Those fulfillment centers mean larger costs of production, which of course means narrower margins. If that’s what Amazon will deliver to investors in the years to come, it won’t be fetching the heavenly premium it has been. That doesn’t necessarily make Amazon a sell. But it makes it a particularly risky stock to own, especially at these lofty levels.

Investors in Amazon have to buy in knowing that, right now, they are investing in a stock where the story is more important than the fundamental underpinnings. And that story could change dramatically as numbers shape up in quarters and years to come.


jekoslosky has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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