To paraphrase the classic philosopher Thomas Hobbes, the selling in Amazon.com, Inc. (AMZN) has been nasty, brutish and short.
This is certainly in stark contrast to last year, when it seemed the company could do no wrong. During that period, Amazon stock logged a massive gain of 118%, compared to a flat-line performance from the S&P 500.
But investors are certainly now in a much more dour mood. Just in the past few weeks, the Amazon stock price has been essentially been a falling knife, with the return at about -29%.
Despite all this, Wall Street analysts remain bullish. For example, JP Morgan Chase & Co’s Doug Anmuth has a price target of $825 to $800 on AMZN stock, while Susquehanna’s Shyam Patil has one at a hefty $900 and Stifel Nicolaus’ Scott Devitt has a $750 target.
OK then, should you follow suit and buy in? Or does it make more sense to hold off on AMZN stock for now?
To see, let’s take a look at the pros and cons:
Amazon Stock Pros
eCommerce Megatrend: According to research from Forrester, the market in the U.S. is forecasted to jump from $334 billion in 2015 to $480 billion by 2019. Of course, this has already meant lots of pressure for brick-and-mortar operators like Wal-Mart Stores, Inc. (WMT) and Macy’s, Inc. (M). And yes, AMZN has been a big-time beneficiary, as the company was able to post more than $100 billion in sales last year. The fact is that the company has major competitive advantages, such as a well-known, trusted brand; extensive distribution; a large customer base (at about 304 million); and cutting-edge technologies, such as with mobile apps and devices. Then there is the Prime service, which has been critical for growth. By getting upfront dollars from customers, AMZN can provide quick deliveries but also various services like video and music that allow for more loyalty. It’s not clear how big Prime is, but in the latest quarter, the growth in membership spiked by 51% on a year-over-year basis.
Cloud Megatrend: This is another key market that Amazon stock should benefit from. Based on research from IDC, the cloud market is expected to go from $49 billion in 2015 to $67 billion in 2018. After all, the technology is generally more cost-effective than older approaches, allows for better analytics, and has been proven to be fairly secure. Interestingly enough, Amazon Web Services (AWS) has been around for a decade and has benefited from the strong core infrastructure that the company has built for its core ecommerce business. And growth has certainly been stunning, with customer base exceeding 1 million. AWS has also remained highly profitable. During the last quarter, the operating profit margin came to a juicy 28.5%. For the most part, AWS has become a way to help fund other parts of the AMZN business.
The Jeff Bezos Factor: There is little doubt that he is one of the world’s best CEOs. Over the past 20 years, he has been able to deal with several boom-bust cycles and has been successful in defeating major competitors. A key has been an obsessive focus on the customer. According to Bezos: “Put the customer first. Invent. And be patient.” What’s more, he is not afraid to make bold bets and take a long-term focus on the business. For example, he has pulled the trigger on many acquisitions, such as for Zappos, Audible, Quidsi, Kiva Systems and Twitch. But there has also been lots of R&D investment, which has resulted in game-changing innovations like the Kindle, Prime and Echo.
Amazon Stock Cons
Costs: This has always been a concern for investors in Amazon stock. And while the company has been showing more discipline, the fact is that the company remains a big-time spender. This was certainly noticeable in the latest quarter, when AMZN spent over $4.5 billion on fulfillment, up about 34%. As a result, the company posted disappointing earnings of $1 per share (the consensus was for $1.55 per share). On the news, AMZN stock took a dive and has yet to recover. And if anything, it seems like a good bet that the spending will continue at a hefty pace. Keep in mind that there are heavy costs for such things as licensing music and video content, as well as building new hardware systems, like the Kindle and Echo. Although, the logistics will remain a big part of the mounting costs. Consider that the company is even thinking of developing its own distribution system to replace United Parcel Service, Inc. (UPS) and FedEx Corporation (FDX). So with investors getting more interested in profitability, this could put AMZN stock in a tough spot.
Overstretch: AMZN is an incredibly complex organization, which includes disparate businesses like cloud computing, entertainment and hardware development. Even though the company has done a good job so far, there still needs to be caution. Let’s face it, AMZN has had notable flubs, such as its disastrous smartphone launch. Besides, the company has been targeting highly competitive markets. In other words, if AMZN gets too distracted or cannot produce standout offerings, there could be deterioration. There may already be signs of this with the cloud business, as the growth rate has been decelerating lately. Keep in mind that the competitive environment has gotten very intense, with top players like Microsoft Corporation (MSFT) making strong inroads. But there are also potential threats from older-line tech operators like International Business Machine Corp. (IBM), HP Inc (HPQ) and even Apple Inc. (AAPL).
Investor Sentiment. Of course, with the recent grueling correction, the tech sector has come under much pressure. Part of this is a fear that overall growth is starting to trail off, as seen with the results from companies like LinkedIn Corp (LNKD). Besides, there may also be a rotation — that is, from growth plays to value opportunities. And even with the recent drop-off in AMZN stock, the valuation is still at hefty levels, with the forward price-to-earnings ratio at 56X. According to InvestorPlace.com’s Charles Sizemore: “About 7% of Amazon’s sales last year came from AWS, and another 19% came from other services. The remaining 74% came from merchandise sales. So, Amazon is still primarily a low-margin retailer, and that isn’t going to change in the immediate future. That means its valuation should be closer to that of Walmart rather than that of Alphabet.”
Bottom Line on Amazon Stock
Again, Amazon is nicely positioned for the megatrends of the cloud and ecommerce. So the growth is likely to continue for some time.
But this may not mean that Amazon stock is at a good entry point, especially since the valuation is still fairly high.
More importantly, investors may be shifting their focus away from growth to value. If so, Amazon stock could be stuck in neutral or suffer further erosion. There may also be issues with the competition, as well as the overstretch of attacking multiple categories.
So should you buy Amazon stock?
No — there just seems to be too much risk on the downside for now.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
