One AMZNgly Overvalued Stock, 2 Peers To Buy Instead

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

Tech has brought you the nightmare dot-com bubble, which was fueled by aggressive growth assumptions. A period of irrational exuberance lifted stocks higher and higher until it became apparent that the market was trying to get something for nothing. While I find that tech provides plenty of upside, the sector contains some isolated bubbles. To gauge which companies are overvalued and which companies are undervalued, I look at various growth scenarios and consider penetrative opportunities. Below, I review three stocks with this strategy in mind.

Amazon (NASDAQ: AMZN): AMZNingly Overvalued

Just when you thought it was over, Amazon continued to gain shareholder value. In last week's trading activity, the stock appreciated by 5.1% despite recently issuing revenue guidance that was below analyst expectations. To get a sense of just how overvalued Amazon is, let's look at what multiples it is trading at relative to other companies:

3M: 1.8x

Altria Group: 1.7x

Amex: 1.8x

Baker Hughes: 6x

Bristol Myers: 2.1x

Caterpillar: 2x

ConocoPhillips: 1.7x

DuPont: 2.8x

Facebook: 1.9x

Ford: 2.6x

Goldman Sachs: 2.1x

Halliburton: 3.7x

Lockheed Martin: 3.8x

Target: 2.8x

Teva: 3.3x

Disney: 1.3x

Walgreen: 3.6x

Yahoo: 5.3x

Are we living in La La Land? If you can trade at 1.7x the world's top cigarette brand, 1.9x a social network widely regarded as extremely overvalued, 2.1x a premier financial titan, 2.6x an iconic auto producer, 2.8x the world's second largest retailer, and 3.3x the world's largest generic producer, you better have a reason for it. But what do we get with Amazon? Not much I'm afraid. On a TTM-basis, free cash flow has actually fallen since the beginning of 2010: from $2.9 billion to $1.1 billion today. Put differently, the free cash flow yield is just below a paltry 1%. By contrast, Microsoft has a 10% yield; eBay (NASDAQ: EBAY), 3.2%; Groupon (NASDAQ: GRPN), 11%; and Google, 5.5%, to name just a few. And, mind you, these tech companies are growing free cash flow.

But Amazon hasn't even been creating value. Its return on invested capital - a metric Wall Streeters use to gauge value creation - is 7.7%, which is below the weighted average cost of capital. Put differently, the company is technically destroying value as the stock appreciates. And this is also 633 bps below the industry average ROIC. Assuming Amazon grows EPS by a terrific 100% annually over the next 5 years (starting with EPS of $1.76 in 2013), 2016 EPS would come out to $14.10. At a multiple of 20.8x (the current sector average), the value would be $293.28 by 2016. This means you would get an average return of just 3.4% over the next half decade assuming these ridiculous assumptions are met.

To get the present value of Amazon, you would need to discount the future value back by 10%. This yields a price target of $182.10. So even with absurdly unrealistic growth expectations--forecasting EPS doubling five times in a row--Amazon's stock is at least 28% overvalued. Analysts, however, only expect 34.1% EPS growth over the next 5 years, which is already an aggressive assumption in light of how EPS just went up 25% over the past 5 years. I believe Amazon is the most overvalued stock on the market right now.

Why You Should Buy eBay, Groupon

And then you have Internet companies that have realistic growth potential ahead that could justify share gains. eBay trades at 18x past earnings has seen FCF grow from $475 million in 3Q03 (ttm) to $2.2 billion in 4Q12 (ttm)--a CAGR of 18.6%. eBay has a ROIC of 17.5%, which is ~390 bps above the sector average. Its major growth catalyst is PayPal, which is coming to the point where it will make up more than half the business.

PayPal is a payment processing system that has been predominantly used through online transactions but is recently being rolled out in brick-and-mortar stores. eBay has guided for $10 billion worth of 2012 mobile transactions, which is reflected in 42% of domestic unique visitors relying on mobile devices and 18% relying exclusively on mobile devices in September. PayPal recently stated that it nearly tripled y-o-y in Cyber Monday mobile payment volumes before 2PM EDT--similar to Black Friday volumes. With comScore forecasting for just 17% y-o-y growth in e-commerce spending, these numbers obviously reflect a business that is gaining share. PayPal has set of doubling its e-commerce market share in North Africa and the Middle East within three years. It is off to a good start having given customers the ability in 7 countries to link their PayPal accounts to bank accounts.

eBay's stock isn't the only good deal in town. Groupon, which has slid 84% from its 52-week low, is now quite compelling. Its free cash flow yield, as earlier reported, stands at an impressive 11%, and the stock is quite cheap at 3.4x book value versus a sector average of 4.5x. And I don't think the company's business model is quite as bad as what the market has made out. Groupon has plenty of penetrative opportunities in traditional e-commerce. In addition, the company has considerable sponsorship opportunities. It recently signed a deal with the MLB to be the sport association's official daily deals partners. With top hedge fund leaders George Soros and Paul Tudor Jones picking up shares, the momentum is starting to turn in Groupon's favor.


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