What's Up With Amazon's High Price Multiples?
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Much ado has been made about Amazon’s (NASDAQ: AMZN) soaring stock price and extremely high price to earnings ratio. Many investors have been left scratching their heads, wondering, “How can this be? The company’s earnings are sluggish and it doesn’t seem poised at all to be able to produce future earnings that justify a P/E ratio 10 times higher than Apple (NASDAQ: AAPL)!”
You’ve likely heard and even joined in on this banter; I joined the discussion last week when I wrote an article on Amazon. Now I want to address some of the things Amazon has going for it and how they clearly show that Amazon is a long term play. That is if you are not stuck on comparing it to tech companies that are not in its peer group.
At the time of writing Friday, Amazon’s trailing twelve month P/E ratio was just under 300. For the year-to-date, Amazon is trading about 42% higher. Amazon’s stock reached all time highs, eclipsing its $246.71, 52-week high, on Aug. 24. The stock continued that trend last week, touching $250 a share during intraday trading on Aug. 30.
The online retailer’s stock is ticking higher as the company has enjoyed a bevy of news events, not to mention its cliff hanger of announcement at the end of August that it would be making a big announcement next week. That immediately was followed by the company announcing that it had sold out of the Kindle Fire tablet. That solidified the belief of speculators that the upcoming announcement, scheduled for Sept. 6, would be the unveiling of a new and improved Kindle Fire.
This new version will directly compete with other 7-inch tablets, including Google’s (NASDAQ: GOOG) Nexus, which is already being sold. Another promising tablet that the Kindle Fire will compete with is Microsoft’s (NASDAQ: MSFT) Surface, which has yet to be released. Last, but not least, is the mini-iPad, which rumored to be coming by the end of the year.
Any updated version of the Kindle Fire will enjoy the same success, if not more, than the original Kindle Fire. The company boasts that the tablet, its first, has been the most popular product that it sells. It’s also the third most popular tablet among consumers in terms of sales. Apple is number one and Samsung is number two.
It’s impressive that Amazon has managed to capture the number three spot, or about 22%, of the rapidly growing, and increasingly competitive, tablet market. One of the reasons Kindle Fire has done well is due to it being powered by Google’s popular Android operating system. Android's dominance could wan, however. Since Apple was successful in proving to a California jury that Samsung infringed its patents when it built its smartphones and tablets, it's thought that Apple could set its sights on Google's Android next.
Then there’s Amazon Web Services, which is the company’s cloud computing business. It has also been wildly successful. When Amazon reported its second quarter revenues in July, it said the total was up 29% to $12.8 billion compared to the same quarter in 2011. Of that total was revenue from the cloud computing business, which was up 57% to roughly $2 billion.
I point out Amazon’s tablet and cloud business because they represent a fundamental shift in the online retailer’s offerings. Originally selling mostly books when it first burst onto the scene in 1994, Amazon has been able to adapt and stay up to speed with the latest and greatest things consumers want. I don’t see this changing; Amazon will continue to excel in offering the latest and greatest products that consumers not only want, but also demand.
Amazon’s efforts with the Kindle Fire and the cloud service have placed pressures on its margins. Part of the reason Kindle Fire has excelled is due to the company’s marketing expenses for the tablet. Expenses incurred while building out the cloud service also have contributed to a rise in the company’s gross margin. These costs are investments and serve a long-term purpose that is bolstering the company’s position in the fast-growing space of tablets and clouds.
Amazon’s gross margins have hovered in the mid-20s. During the second quarter, they were 26.1%, which was slightly higher than the 24.1% reported during the second quarter of 2011. Moving forward, the company’s third quarter gross margin is expected to be 25.1%, and then 21.5% for the fourth quarter.
The biggest hurdle Amazon must overcome to gain more investor confidence deals with its earnings per share. They have dropped from $1.82 to about $0.62 over the past five quarters, which shows that the company’s growth rate has slowed. This is also fueling the belief that the company is overvalued.
Sure, it’s easy enough to look at Amazon’s price multiples in comparison to the likes of tech giants like Apple and Google and scream ‘Bloody Mary.’ You can even try to make the same comparison to companies in Amazon’s immediate peer group, such as other retailers like Wal-Mart. However, considering price multiples should be one, not the only, tools used in choosing an investment, I think Amazon has many attributes that show it is very much so poised for substantial growth, leading to its EPS strengthening and its market cap growing.
TwillyD has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, Google, and Microsoft. Motley Fool newsletter services recommend Amazon.com, Apple, and Google. 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.
