Is Amazon Due For A Dip?

Amazon (AMZN)

Citigroup recently placed a buy rating on Amazon and sees shares climbing an additional 25%. Goldman Sachs has upped the price target on Amazon to $180. Deutsche Bank has a $180 price target on the shares. Piper Jaffray has a $172 price target and a buy rating. Kaufman Brothers and FBR Capital have a $160 price target on Amazon’s stock. While Amazon is a fantastic company with a sustainable business model and increasing market share in the retail industry; now is not the time to buy Amazon.

The stock is trading at 34 times next years projected earnings and trades at 2 times sales. Amazon’s battle with Walmart has forced the online retailer to sacrifice gross margins for earnings growth. Gross margins came in at 22.9% compared with 23.5% last year. Now that Google will be selling digital books soon Amazon may see its margins squeezed further. Operating margins for books, DVD’s, and music have already dropped below 6% this year. In the past Amazon has traded at a premium multiple because of its high growth rate. Amazon grew earnings 45% over the past five years. EPS is expected to grow at half the rate in which it has over the past 5 years. Based on its five year EPS growth rate, you can conservatively place a 27.1 P/E on Amazon. Multiply that by the $3.91 earnings estimate and Amazon should trade at roughly $106 per share. Add in the cash on the balance sheet and Amazon is worth about $120.

My estimate is high according to an article in Barron’s. Singular Research sees a $40 price drop for Amazon valuing the retailer’s shares at $90. According to Singular, the “cost of capital of 9.65% and a long-term growth rate in after-tax operating income of 10%, (based on a reinvestment rate of 50% and a return on capital of 20%). After combining the present value of the interim cash flows and the terminal value, the current cash on Amazon’s balance sheet, less debt and option stakeholders’ claim on Amazon’s equity, we calculate a value of roughly $90 per share.”

I am not suggesting that you run out and dump all of your shares because Amazon still has a pristine balance sheet and a major competitive advantage over Ebay and other online retailers. I am suggesting that you should be careful with Amazon’s shares however because stocks that trade at premium valuations decline the most when the market drops.

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