Professor Bainbridge...on law, politics, religion, culture & food

Is Amazon Over-Priced?

Given the substantial amount of money I spend on Amazon, I’ve often pondered making it an exception to my rule against owning individual stocks. On current values, however, shorting it seems more tempting. As Evan Newmark asks:

… how can one reconcile a company which earned $476 million last year with a market cap targeted by Wall Street at over $40 billion? Eleven years since going public, the company still has negative retained earnings, meaning that its cumulative losses have exceeded its profits. Its shares trade today at about $81. The consensus target share price on Wall Street is about $100.

The Amazon story continues to be all about the future. Goldman Sachs’ James Mitchell says Amazon can sustain 20%-plus revenue growth for as long as 10 more years. That rate would give Amazon over $120 billion of revenues by 2018 from a base of just under $20 billion projected for this year.

Where does all the revenue growth come from? Lots of assumptions. Assumptions about domestic and international market growth in e-commerce, Amazon market share gains and Amazon’s Prime program.

Prime is an offering that subsidizes customer shipping costs as a way to entice customers to place more orders. Here is Goldman’s math: It estimates the current Prime penetration rate, multiplies that by an estimate of the addressable market and then multiplies that figure by an estimate of increased revenue per user.

An estimate on top of an estimate on top of an estimate. This is Internet bubble logic. And the numbers really start to grow.

The same goes for Kindle, Amazon’s portable electronic reading device. Mark Mahaney, a Citi analyst, draws a parallel with Apple’s iPod and iTunes. He suggests that by 2010, Amazon will be selling $741 million worth of Kindle gear per year.

Across the board, both investors and analysts are willing to give Amazon the benefit of the doubt. A potential recession? This will shut down retail stores and help Amazon. A new “Amazon” law slapping sales taxes on New York State e-commerce? Not a fundamental risk.

Historically, investors have been more concerned with Amazon’s gross margins than its revenues. On margins, Amazon has frequently missed estimates.

Regarding this spotty history, Goldman has a novel argument: Amazon has now proven its business model, so it’s safe to assume stable margins going forward.

As Newmark nevertheless observes, however, to short Amazon in the face of this pattern of gravity defying success would be crazy. If you think the maket is being irrationally exuberant about Amazon’s prospects, as I do, however, you’d be equally crazy to go long on it.