Investor exuberance over Amazon.com has risen throughout 2015. Spurred on by a string of quarterly reports showing year-over-year sales growth -- 15% in the first quarter, 20% in the second quarter, and 23% in the third quarter -- the company's stock has more than doubled since the beginning of 2015. Added to that is the fact that, over the trailing nine months ending Sept. 30, Amazon has turned out positive earnings for shareholders -- $0.24 per share, to be exact. Compare this with the first nine months of 2014 whenAmazon was reporting a loss of $0.99 per share.
Despite the positive year, I would urge caution for investors in the Internet retail behemoth. I love Amazon -- my wife and I are Prime members, and we're frequent users of the company's multiple services. I believe, though, that current share prices have far surpassed what is reality. Here are my reasons for being a contrarian.
The problem with investing and receiving little returnIf you've followed Amazon for a while, you no doubt remember that as early as last year, investors were getting increasingly frustrated with a lack of positive earnings. CEO Jeff Bezos' argument was that the company takes a different approach to returning value to shareholders, opting to reinvest all profits into new product lines and technology to drive overall revenue growth. To demonstrate this, total netinvestments for the nine months ending Sept. 30, 2014, were $2.6 billion. In the nine months ending Sept. 30, 2015, that figure had nearly doubled to a cost of$4.6 billion. The lion's share of that investment has gone toward the purchase of property and equipment, which includes the upkeep of Amazon's website.Up to this point, there has been no statement from management that the strategy has changed. The reason givenfor the heavy reinvestment is to stave off competition, which is quite fierce in the retail space, and it appears that heavy reinvestment is continuing.
At some point, though, earnings have to be returned to shareholders. While increasing total revenue (aka sales) isa greatway over the long term to drive business value, it does have an upward limit. There's only so much revenue to go around. In 2014, in the Internetretail space, that number was estimated to be just shy of $300 billion. Amazon's share was about $55.5 billion, or about 18% of the total market.
What if Amazon's growth in the online retail sales industry were to slow? Or what if retail sales growth in the U.S. were to decline? Investors are assuming very large increases in the top and bottom line, but Amazon has a 0.33% net profit margin and a 1.70% operating profit margin over the past 12-month period. To say there's a very small margin for error here is an understatement. Return on assets and return on equity over the last 12 months are at 2.22% and 2.88%, respectively. At some point, reinvestment of earningshas to provide a return for those who are offering the cash as equity to justify the risk.
Everyone's gunning for AmazonAmazon is the clear leader in the U.S. in the online retail space, and everyone else is trying to play catch-up, as Amazon already has the infrastructure to accommodate large amounts of orders online. More importantly, it has the infrastructure to deliver those orders efficiently. However, other retailers have been investing in their online efforts, and results are starting to roll in. Here's an example, taken from third-quarter earnings results:
Sources: Amazon, Wal-Mart, Target, and Home Depot 2015 quarterly earnings results. Quarters are for the fiscal year 2015 for each respective company.
Retailers across the board have become wise to the trend toward online purchasing. And as the results show, Amazon isn't the only company benefiting from that trend. Some retailers are even outpacing Amazon in online sales growth and gaining market share in the online space. The argument in the past has been that Amazon has a clear advantage in the online space because it's unencumbered by the overhead of brick-and-mortar stores. The opposite, however, is true. Amazon has, and continues to invest in, distribution centers and delivery methods. Inthe Q3 earnings results, the company reported having spent $3.28 billion to purchase property and equipment through the first nine months of the year. Amazoncurrentlyhas 76 distribution centers and 18 sorting centers in North America, and plans are underway for more than a dozen more. Traditional retailers already have physical stores with inventory in them, thus giving them the ability to distribute online purchases quickly to local buyers,as well as offer customers something Amazon can't: in-store pick-up rather than delivery.
One final point here bears particular importance. All of the companies I've listed have invested in online sales. All of them, with the exception of Amazon, have still been able to return value to shareholders with not only positive earnings, but also dividends and share buybacks. While Amazon is currently the online store market-share leader, other retailers are gaining and creating wealth for investors. Amazon lags behind the competition from this standpoint.
The problem with current stock pricesFinally, there is the concern with the current stock valuation. I always become leery when both investor and analyst expectations soar to sky-high levels. (As a recent example, read this article I wrote for The Motley Fool and the follow-up article.) We have to remember that current stock prices are a reflection of not just the recent past, but also future expectations. Share-price increases grow in likelihood when near-term expectations are exceeded, as current share prices usually have already priced-in expectations. That said, what are the near-term expectations for Amazon stock?
Source: Yahoo! Finance.
Let me clarify one thing. I do believe Amazon will continue to grow and thrive as shoppers shift to online buying in the coming years. However, I believe that the numbers speak to an overvaluation of the current stock price. Is one-year earnings growth of nearly 200%, or doubling twice over, realistic from a company that's dedicated to reinvesting earnings into new technology and product offerings? Is a PEG ratio (a measurement of price per unit of future growth expectation)four timesthat of competitors warranted, when the competition has been demonstrating growth in sales and earnings, as well as strong growth in Amazon's key business of online retail sales? I believe these to be important questions for shareholders, or potential new shareholders, of Amazon stock to consider.
Great company with a high price tagI would like to reiterate one last time that I do like Amazon as a business. I believe it will continue to innovate the way people shop for goods and services. However, I'm currently taking a contrarian view on the stock because of the lack of a plan to return value to shareholders, competitive headwinds, and current share prices. Despite the strong performance year to date, I urge investors to be cautious.
The article Should We Be Excited About Amazon.com, Inc.? A Contrarian Perspective originally appeared on Fool.com.
Nicholas Rossolillo owns shares of Target. The Motley Fool owns shares of and recommends Amazon.com. The Motley Fool recommends Home Depot. 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.
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