Amazon.com, Inc. (NASDAQ:AMZN) stock is up 12% year-to-date, after an even more impressive 2015 when AMZN stock more than doubled. Amazon hit its 52-week high at $847 on Oct. 6, but tumbled after disappointing on earnings later that month.
After the election of Donald Trump, who had engaged in a war of words with Amazon CEO Jeff Bezos, AMZN stock fell further, closing at $719.07 on Nov. 14.
Trump accused Amazon of violating antitrust law and suggested that Jeff Bezos was using the Washington Post for political influence and tax shelter. Trump warned that Amazon and Bezos are “going to have such problems” once he is elected.
For his part, Bezos announced his dream of sending Trump to outer space. Since then, Amazon stock has rebounded to around $760 right now, as Trump appeared to have softened on Amazon, holding a summit with top tech CEOs on Wednesday.
Some see the decline in Amazon stock as a temporary pause and buying opportunity. About that …
Don’t Buy AMZN Stock!
Stocks generally perform better when the market’s expectations are low. If expectations are high, so is the risk of disappointment. Bye-bye valuation. If the market expects little, the chance of surprising on the upside is higher.
The media and analysts fawn over Amazon stock. With a mean analyst rating of 1.9 on Yahoo Finance (representing a “buy”), opinion seems split between those who view Amazon stock as a “buy” and those who view it as a “strong buy.” The mean analyst target for Amazon stock is $929, implying a 23% upside.
When a the market overvalues stocks and expectations are high, we will see cases of irrational exuberance in the media. People will write books titled Dow 36,000 and talk about certain tech companies hitting $1 trillion in market cap (in this case, Cisco Systems, Inc. (NASDAQ:CSCO) in 2000, which did pass $500 billion before the tech bubble burst).
We are seeing such optimism with Amazon now. Ark Invest CEO Catherine Wood and RBC Capital managing director Mark Mahaney made such predictions this year. These bullish estimates still fall short of venture capitalist Chamath Palihapitiya’s forecast of Amazon as a $3 trillion company.
When Amazon Web Services first launched expectations were low, and AWS pleasantly surprised analysts. Amazon would get laughed out of the room. Now, the public feels that Amazon will conquer the world.
Amazon trades at 176 times earnings, and its valuation looks frothy on other measures as well. Even relative to Amazon’s past experience. The price-book ratio stands at 20.5, above the 13-year median of 14.96. The price-sales ratio, at 2.85 hovers above the median of 2.02, and is not too far off the 13-year high of 3.16.
Bulls might retort that the market has overvalued Amazon stock for the past 15 years, during which it still managed to soar from $6 in August 2001 to $840. At any rate, further margin expansion seems improbable, especially since Amazon is now a $360 billion company.
Investors Will Rediscover Value
Historically, value stocks generally outperform growth stocks. During times of lackluster growth in the real economy, growth stocks such as Amazon tend to do well. During times of fast growth, value stocks perform better.
This trend reversed in the aftermath of the 2009 recession. Growth returned, yet value stocks continued to underperform. The gap between the performance of the market and of value stocks widened since 2007. This may be due to low interest rates reducing the cost of borrowing.
And investors lost their patience with most stocks, where management plugged profits into buying back shares rather than investing in future growth. Investors were willing to pay a premium for growth, since companies that were actually investing in growth could not be easily found.
However, stock buybacks have decreased in 2016. This should erode the growth premium commanded by stocks such as Amazon. With high corporate profits and stock prices relatively overvalued, interest should further shift to value stocks.
Bottom Line on AMZN Stock
Instead of buying Amazon and paying a premium, investors should look for conservatively valued stocks. Stocks such as Cisco and Apple Inc. (NASDAQ:AAPL) will benefit from investors rediscovering value stocks.
Cisco trades at 14.5 times earnings, 12 times forward earnings and 2.4 times book value. Cisco holds $14.12 of cash per share, a whopping 46.3% of its market capitalization. This suggests that the market expects little from Cisco, giving it a higher chance of surprising on the upside.
Tech stocks like Cisco also welcome a rise in interest rates since it will increase interest payments on their cash. So hold off on buying growth stocks at stretched valuations like AMZN stock.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.