(AMZN) Stock – Pros and Cons of the Online Superstore

Falling Kindle profit margin remains big problem for Amazon (NASDAQ: AMZN) is the quintessential Internet retail stock.  AMZN has proven that millions of book titles, along with countless other items from housewares to handheld electronics, equal millions of dollars in profits.

In fact, Amazon shareholders have enjoyed a very nice +15% ride higher over the last three months (through Sept. 10), but it’s over the long term where CEO Jeff Bezos and company officials have really raced up the river. Over the past 12 months, AMZN stock has gained about +70%, crushing the performance of stocks in the wider broadline retail segment.  And, if you were fortunate enough to own Amazon shares over the past five years, then you’d be sitting on a stunning +232% gain.

Yet despite the clearly outstanding performance in Amazon’s stock, and in the company’s bottom-line growth over the years, things haven’t been all smooth sailing.

In July, the company failed to meet second-quarter earning’s expectations even as revenue and operating income rose well above 2009 levels.  Many investors on both Wall Street and Main Street remain bullish on AMZN going forward, but there’s a growing chorus among both segments claiming that now is the time to get off this riverboat.

Let’s take a look at some of the pros and cons for Amazon stock to see what the future holds for this tech powerhouse:

Reasons to Buy Amazon Stock

Kindle is red hot.  Amazon’s premier product is its Kindle e-reader.  The company has enjoyed tremendous success from the Kindle and despite stiff competition in the e-reader market from the likes of Apple (NASDAQ: AAPL), Barnes & Noble (NYSE: BKS) and Sony (NYSE: SNE), the Kindle is still the item to beat.  Since Amazon introduced the new Kindle versions in late July, they’ve been effectively sold out.  Recently, investment firm Caris & Co. increased their estimates for Kindle-unit sales and revenue contribution for 2010 and beyond. Caris now expects the Kindle will generate revenue of $2.81 billion (on 4.8 million unit sales) and gross profit of $553 million in 2010. By 2012 they expect $5.32 billion in total revenue and $1.34 billion in gross profit.  Caris also believes the Street is underestimating the continued revenue impact from Kindle sales on Amazon’s bottom line.

Biting into Apple.  Amazon has shown that it’s not afraid of a good fight, and that’s what it’s about to engage in with Apple. The company’s recent acquisition of online music store is part of its plans to get in to the digital music business, a business clearly dominated by Apple.  If successful, Amazon’s new venture could lead to a nice boost to their bottom line.  The move also shows that Amazon’s management isn’t content to rest on its existing laurels, and that’s a key quality to look for when investing in any company’s future.

Breaking out of a base.  From a technical perspective, we see that AMZN shares have now broken out of a base that formed in August.  At the outset of September, buying in the stock began to ramp up, and in just a few trading days the bulls sent the stock well above its long-term, 200-day moving average.  This can be read as a bullish sign for AMZN shares going forward, and the recent surge in the shares could very well bring about even more buying going forward.

Reasons to Sell AMZN Stock

Falling Kindle margins.  In an effort to not be outdone by the competition, Amazon now is engaged in a price war with Kindle’s rivals.  The company has reduced the price of the e-reader substantially, from $399 in 2007 to $259 last year. Now, its latest model (the Kindle DX) sells for just $189. The price cut will likely put pressure on Kindle’s margins, but Amazon’s hoping the reduced margins will be made up for in higher sales volume.  Those on the con side of the AMZN debate aren’t convinced, but we’ll all see how well Amazon comes out of this price war when the company reports its third-quarter results in October.

The earnings equation.  Traders showed little mercy on AMZN shares after its most-recent quarterly earnings report (released on July 23). The stock was down big after the company reported it earned $207 million, or 45 cents a share, on revenue of $6.57 billion. Though that’s a whole lot of profits in Q2, analysts were anticipating earnings of 53 cents per share.  Operating income rose some +71% to $270 million, but even that was a disappointment, as analysts had been looking for a number closer to $320 million. Fulfillment costs in the quarter were higher by some +42% to $582 million, while marketing costs rose +64% to $211 million.  This earnings equation of higher costs and reduced Kindle margins has the Amazon bears fired up.

Overbought territory? As we’ve already seen, there is no-doubt that Amazon shares have enjoyed a big breakout above the technically significant 200-day moving average.  The pros say that’s a bullish sign, but the cons say otherwise. The argument against AMZN shares from a technical perspective is one of overhead resistance at the $140-$150 level.  The shares currently trade right about $145 (as of Sept. 13), and the buying will have to be pretty substantial to get the stock into new-high territory.  If the overall market makes yet another downturn, we are liable to see AMZN shares sell off hard before making new highs.

The Verdict on’s stock certainly appears to be at a critical juncture here.  Technically, it’s pushing up on its 52-week highs after a sharp rally higher.  That means we could either get a nice breakout here, or more likely, an even sharper pullback back down to the 200-day moving average.  Fundamentally, the company has had some trouble meeting expectations of late.  However, if Amazon can be victorious in the new e-reader price wars, and/or if it can ramp up new businesses such as online music, we could see a nice boost to the bottom line.  I think the verdict here with respect to AMZN shares is, well, a push.  If you’re a short-term trader, the verdict goes to the cons, particularly after the latest run higher in the stock.

If you’re a long-term investor who is unafraid to hold through a little short-term volatility, then AMZN will likely be a winning bet for some years to come. 

As of this writing, Jim Woods did not own a position in any of the stocks named here.

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