Why Amazon Stock Could Be Hurt by a Lack of Focus

Amazon stock - Why Amazon Stock Could Be Hurt by a Lack of Focus

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Amazon’s (NASDAQ:AMZN) forays into so many complex businesses could be hurting the company’s core e-commerce unit and could eventually cause the valuation of Amazon stock to decline. When combined with the high valuation of AMZN stock and the dangers posed by President Trump’s animosity toward the company, this problem makes Amazon stock very risky and unattractive at current levels.

AMZN Is Becoming a Conglomerate

As InvestorPlace‘s Luke Lango recently pointed out, Amazon is looking to enter many new businesses, including  offline retail, digital advertising, logistics and chips. Additionally, the company may look into selling prescription drugs and it’s part of a partnership that’s more or less seeking to reinvent the American healthcare system. All of those businesses, with the possible exception of digital advertising, are incredibly complex and have many moving parts. And the intense competition in digital advertising makes that pretty difficult too.

And if that’s not enough, Amazon CEO Jeff Bezos also owns The Washington Post —  and AMZN is going to build two new headquarters soon.

Given all of these new ventures, Amazon seems to be becoming a conglomerate. As a result, the owners of Amazon stock could soon hold shares in a conglomerate that has some similarities to General Electric (NYSE: GE). Specifically, both companies will own many complicated businesses, several of which have little or no connection to each other.

Is Amazon’s E-Commerce Business Being Hurt?

With all of these incredibly complex balls in the air, it’s hard to imagine how Bezos and his top executives can focus very much on the company’s core e-commerce business.

Amazon’s lower-than-expected third-quarter revenue and its Q4 top-line guidance miss, which caused Amazon stock to drop sharply, may have been partly caused by this lack of focus. And this dearth of attentiveness is coming at a bad time for AMZN, as some older, brick-and-mortar retailers like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) are stepping up their e-commerce games.

The Valuation of Amazon Stock

As InvestorPlace‘s Will Healy pointed out in October, the valuation of Amazon stock is “excessive.” Although the forward price-earnings ratio of AMZN stock, based on analysts’ consensus 2018 earnings-per-share estimate, has since fallen to 58 from 68 when Healy’s article was written, the valuation of Amazon stock definitely hasn’t reached bargain levels. Therefore, if the company’s e-commerce business does lose ground, Amazon stock could easily slide much further.

Another phenomenon that could hurt Amazon stock is the so-called “conglomerate discount.” According to Investopedia, a conglomerate discount “refers to the tendency of markets to value a diversified group of businesses and assets at less than the sum of its parts.”

The website indicated that one of the reasons for the conglomerate discount is that “history shows that conglomerates can grow so large and diversified that (they become) difficult to manage effectively.” Thus, if investors begin to sense that Bezos and his team are having difficulty managing the conglomerate they’re building, then the valuation of Amazon stock could drop sharply. Indeed, the recent declines in the valuation of AMZN stock could partly stem from the surfacing of such an idea among investors.

Jack Welch’s Axiom and Learning From Immelt’s Mistakes

Former GE CEO Jack Welch, probably one of the two most successful heads of a conglomerate of all-time (the other, of course, is Warren Buffett), had a rule that each of GE’s subsidiaries had to be either first or second in its market. Welch’s idea was “to focus the company on the businesses where it had the potential for greatness,” according to Harvard Business Review.  He lowered the number of the company’s units to 15 from 150.

Conversely, Welch’s successor, Jeff Immelt, made more than $175 billion of acquisitions, taking the conglomerate into subprime mortgages and oil exploration equipment and greatly expanding the size of the conglomerate’s ill-fated financial unit, GE Capital.

Bezos’ defenders will argue that Immelt had many other deficiencies that Bezos doesn’t seem to have, such as an unfortunate tendency to make horribly timed acquisitions, an apparent lack of interest in managing day-to-day operations and an inability to exercise fiduciary responsibilities. Moreover, Amazon’s CEO has been much more successful than Immelt ever was.

I would agree with all of the latter arguments, but since Amazon probably isn’t likely to become the first- or second-largest player in fields like prescription drugs, chips or logistics anytime soon, and since Bezos is rapidly adding businesses to Amazon,  it seems that he has taken to following the disastrous Immelt model more than the largely successful Welch one. That course could ultimately spell trouble for Amazon stock.

Another Headwind Facing Amazon Stock

As I predicted in August 2017, the animus between Bezos and President Trump seems to be hurting Amazon stock. Specifically, after intervention on the issue by Trump, the post office looks set to raise the rates on the shipping service used by Amazon. Credit Suisse estimates that the increase will lower the company’s 2019 earnings per share by almost 19%.  The administration could still unveil additional initiatives that will hurt AMZN and Amazon stock.

The Bottom Line on Amazon Stock

Although Amazon has strong growth opportunities in e-commerce, digital ads and the cloud, the high valuation of Amazon stock, along with the company’s lack of focus and the animus of President Trump toward Bezos and AMZN, make the risk/reward profile of Amazon stock unappealing.

As of this writing, the author did not own the shares of any of the companies named. 

 


Article printed from InvestorPlace Media, https://investorplace.com/2018/12/why-amazon-stock-hurt-lack-focus/.

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