Forget drones: Here's why Amazon is a 'sell'

Jeff Bezos knows how to get the media excited about his company. But is that enough?

By StreetAuthority Dec 5, 2013 3:22PM
File photo of Jeff Bezos on Nov. 16, 2012 (© Peter Kramer/NBC/NBC NewsWire via Getty Images)By Jody Chudley, StreetAuthority

As the Thanksgiving weekend wound to a close Sunday night, I happened to watch the "60 Minutes" interview with Jeff Bezos, the billionaire CEO of Amazon.com (AMZN).

At the end of the interview, Bezos (pictured) unveiled a "surprise" for correspondent Charlie Rose and his TV viewers, revealing that Amazon is working on building flying drones that can deliver packages directly to customers.

I thought that was maybe a bit far-fetched, but certainly interesting. However, the media grabbed onto the drone story and ran with it. All day Monday, every news channel I watched -- financial and otherwise -- was talking about Bezos, Amazon and drones.

Bezos certainly knows how to create a buzz. What has yet to be seen is whether he can generate profits for Amazon shareholders.

How about some profits?
Amazon is a fantastic and innovative company. I don't dispute that for a minute -- I think that's an inarguable fact. But another fact that I think investors should be aware of is that this company does not generate significant profits or free cash flow.

It is a bit hard to believe, considering that the company is well into its second decade, but it's true. When you consider Amazon's lofty stock market valuation, I think that lack of profitability creates a lot of risk for investors who own shares at the current price.

I think the numbers speak for themselves in this case. Amazon has roughly 460 million shares outstanding and a share price around $390. That gives the company a market capitalization of $180 billion. That is big.

Would you like to know how much net income Amazon is on pace to generate in 2013?

None. Same as last year.

Now before you accuse me of being shortsighted, let me tell you that I "get" the strategy. Amazon intentionally keeps its margins extremely thin to build customer loyalty and critical mass. The company also spends a large amount every year on research and development to further strengthen its online dominance.

I don't just "get" the strategy, I agree with it. What I don't agree with is the price investors are currently willing to pay for Amazon shares. I think it's a mistake for investors to buy shares in a company with zero profits and a $180 billion market cap.

I believe that exposes investors to all kinds of risk of loss, while offering very little chance for long-term gain.

The 'Wal-Mart of the Web' vs. Wal-Mart

Amazon's strategy is to become the Wal-Mart (WMT) of the Internet, a company that can dominate potential competitors because it is always able to offer the lowest price to its customers. It makes sense then to compare the current valuations of Amazon and Wal-Mart.

Amazon has a market capitalization of $180 billion. Wal-Mart has a market cap of $260 billion.
       
Amazon's shareholders get ownership in a company that generates no net income. Wal-Mart's shareholders get ownership in a company that is generating $17 billion of net income.

Wal-Mart's share price and market valuation are supported by some very real income that the company is generating. Amazon's share price and market valuation are based on nothing more than the belief that the company will someday generate tens of billions of net income.

Amazon's stock price is built on faith, not on profits. And that is dangerous business for investors. All it will take is for one negative thing to appear that raises some doubt about Amazon's ultimate potential for profits and that belief could be weakened. And when a stock price is built on faith instead of profits, there's no telling how far it can fall when doubt emerges.

I have no doubt that Amazon will at some point be a very profitable company -- but I do question how profitable. To justify a $180 billion valuation, I would suggest Amazon would eventually need to make $9 billion a year (which would be a price-to-earnings ratio of 20).

Amazon is going to have sales of about $65 billion this year. To go from zero profits to $9 billion would require some huge margin expansion -- and much higher prices for customers.

Wouldn't that do serious damage to Amazon's business model? And how much product could Amazon sell with such an increase in prices?

Creating enough income to ultimately justify a $180 billion market capitalization is going to be difficult. Creating enough income to justify an even higher market capitalization will be nearly impossible, and if not it will take many years to do.

I think buying shares of Amazon at this valuation is all risk and very little chance for reward.

Risks to consider: Shorting any company is very risky, as there is no limit how high share prices can go. Over time, valuation matters, but in the short and medium term, valuations can get progressively more irrational.

Action to take: If you own Amazon, you should probably sell it. If you don't, a small short position might be profitable. The upside potential from a valuation of $180 billion is nowhere near the possible downside if investors lose faith. Eventually, earnings and cash flow matter.

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24Comments
Dec 5, 2013 5:03PM
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Still laughing MAO....Funny how some of these rich and celebs can throw shidt out, and there are people buying it as FACT....


We have turned into Drones and Morons, wrapped in a fool.

Dec 5, 2013 8:39PM
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At least Amazon provides physical products.  Twitter and Facebook are there just for entertainment. 
Dec 5, 2013 5:47PM
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At least the actual article heading is grammatically correct [....Amazon is a 'sell.'...] vs MSN's the lead in to the article [...Amazon's a 'sell.'] e.g. possessive (Amazon owns "sell"?).  And, we honestly wonder that the U.S.S.A has fallen behind third world countries in educational acumen.
Dec 5, 2013 9:02PM
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Amazon isn't going to make it. Sure, everyone marvels at a novelty, but much like Wal-Mart, it will cycle through "novel" and fall on it's face trying to get to Growth then Maturity. Amazon requires a lot of supply coming from someplace cheap and suckers here will pay oodles for and then skip out on the sales taxes. All that generates is a post-event tax like the one we're heading for-- where we have to all pay for the cheapskates. 

It's a FACT that Amazon doesn't profit from it's activity, just it's ads and fools who keep investing in an Albatross. When you are made out of nothing... that's your true value.

Dec 6, 2013 10:35AM
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You Rant!!!  People have said what you are saying for $300 points. This company has repeatedly increased its sales (20%) and market share.  Investors are looking at earnings in the out years. Amazon dominates in retail and the cloud. They have $7.69b in cash on the books with operating cash flow of 4.98b with free cash flow of $1.48b. Their CapX expenditures will one day slow down and then you will see earnings ... the out years. And Jeff Bezos is one of the Best CEOS in America. I don't currently own this stock ... but I understand it. 
Dec 6, 2013 8:32AM
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A good example is- micro-breweries. Most utilize smaller equipment, much of it refurbished or retro-fitted, to make small batch quality. They can exist in light industry buildings, old warehouses, or a basement you name it, and produce a high-demand quality product. No matter how much BIG tries to scale down to compete in this arena, the little guys are collectively controlling the market.

What these big virtual anti-enterprises have done is to wipe out a seemingly perpetual business model (Ye Old Everything Store) moving it online. But it's premise-- shipping is becoming a dangerous unaffiliated problem. Bezos is toying with drones. Can you see millions of them flying slowly carrying potential problems over us? There is an old story about having mice in your home so you buy a cat, who has too many kittens, so you buy a snake who eats so many kittens that it grows large enough to consume you and does, then lives happily ever after in your home alongside the mice that are too small to chase for dinner.

Stop trying to invest in anything and go DO something with your money. 100% of all investors are about to lose everything because there are too many spectators and not enough players in an economy recovery. QE will be forced out, all addicts relying on it will disappear, as will the stocks they sold you. NO publicly traded entity has anything valuable left in it. All that was valuable- is fully capable of generating new enterprise without the inheritors and administrators. And will. 2014, the year will be historic... it's the New Century New Year because if it isn't, it's the onset of WW III.

Dec 5, 2013 5:41PM
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First of all, this is not a capitalistic country it is a representative democracy...corporations are ALLOWED to exist here to serve citizens not shareholders.  If you have any doubt of this, do your home work.  Secondly, Amazon meets and exceeds that goal.  It provides Americans with wonderful purchase experiences and exceptional technology a fantastic prices.   If shareholders are not getting their bang for the buck, what they are getting is what those who allowed corporations to exist intended....a bargain for the American consumer.  Wal-Mart prides itself in paying low wages, sending their employees to government agencies for assistance and squeezing American businesses out of their way by shifting production to their sweatshops in China all to provide profits to their shareholders and in particular to Wal-Mart family members who do nothing for the company but are at the top of the list of the richest people in the country. 
Dec 6, 2013 8:33AM
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There is no more connection between Obama and Bezos, than the entire Party of NO pledge gang and the Koch Brothers. We are talking ENTERPRISE on this blog, where business models that Wall Street says are solid, but nothing generated from their model efforts is staying in their wallet. ALL people are growing disenchanted with ads and the premise that exploitation in-you-face 24/7/365 marketing is a viable GDP. It's more Gross, than Productive. That will sink all these virtual nothings.
Dec 6, 2013 8:33AM
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"Internet commerce is low barriers of entry business and all brick and mortar stores will be there"

You ABSOLUTELY don't know what you are talking about here. While BIG like Amazon are large and seemingly in domination, small businesses are faring extremely well doing what Amazon cannot-- extend quality and personal attributes. Amazon is a warehouse that ships homogenized inventory. TRUE online commerce is a bridge linking anyone anywhere to your enterprise and the tools to create a meaningful experience.

This era of controlled and manipulated corruption commerce and cram-down marketing will pass because it's unsustainable. SMART entrepreneurs aren't going all-in on hedged bandwagon holdings, they are investing in surplus that can be reconstituted into actual enterprise and future-state business models. As for brick and mortar-- old structures hoarded by REITs along main streets where traffic is distracted--- is 20th Century. Our BEST enterprises don't have main street store fronts, nor are they fully virtual. They are destinations thriving where you would least likely think they would, and that's a FACT.


Dec 6, 2013 8:32AM
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The future-state is exciting. I can produce something in reasonable quantity and market it online- priced intelligently to cover my overhead and a reasonable margin profit, just like original trades and crafts people did. I sell out. I go make something else and there is a demand. Quality trumps quantity, unique trumps massively produced. Price has to be what the buyer can afford and not psychopathic must-have-to-show-I'​m-special priced. YOU need to realize that millions are already doing this and thriving. Deep discounters and online bottom-feeders are not. If you don't profit from the actual sale, you gave your existence away. THAT is the business model Wall Street thinks is worthwhile. It is not. The only "old" worth remembering is-- fools and their money are quickly parted. Don't be a fool, invest in what YOU can control by effort, not what some paper and button pushing salaried zombie says is- "good".
Dec 5, 2013 9:37PM
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shorting amazon is risky since owner is financial supporter of Obama as payback Obama inflates its stock using fed money borrowed with no  collateral from bail out banks by middlemen.ItS unlawful but senate knows it and do nothing.Also amazon doesn't need to make profits because owner makes billions selling inflated options and stocks.He pays media to promote amazon stock and making innocent investors greedy for future dream profits and selling stocks to 401k funds.Also amazon is still not paying sales taxes in more than half the states without this competitive privilege amazon is not a viable company and is costing thousand of jobs from brick and mortar retailers.SO if u own amazon sell it but don't shortsell as long as Obama is in power and has majority in senate he will keep doing illegal things like making amazon owner richer than god without amazon making any profits.Internet commerce is low barriers of entry business and all big brick and mortar stores will be there.also some producers will sell direct to get instant payment
Dec 5, 2013 6:04PM
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Picky vitalization virulent affirmed as\gone dysfunctional via labor clause.
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