Amazon Stock Looks Poised to Be Hit by Multiple Compression

Amazon (NASDAQ:AMZN) stock has continued to fall along with the market. For the most part, the decline is not the fault of the company. An intensified U.S.-China trade war and the yield curve inversion have made investors uneasy, weighing on AMZN stock and most other equities.

Buying GrubHub Would Fortify Amazon Stock Well into the Future
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However, problems unique to AMZN have also hurt the stock. Moreover, the company does not pay a dividend, and its valuation exceeds that of other mega-tech companies. Given these factors, the price–earnings (PE) ratio of Amazon stock appears set to fall further.

Beware of Falling Valuations

The yield-curve inversion has an effect on AMZN and other hot tech stocks that receives little attention. Specifically, the inversion facilitates multiple compression.

Amazon stock has traded at an elevated PE ratio, often reaching PE ratios of 100 or higher. Investors can attribute much of its recent swoon to the law of large numbers. However, in recessionary environments, even the hottest of companies struggle to hold onto their premium valuations.

The forward PE of AMZN stock has now fallen to about 53. Even after the  company’s disappointing earnings report issued in July, analysts still, on average, expect profit growth of 16.6% this year and 41.4% next year. Typically, given the high profit-growth estimates, the elevated PE would not concern me. However, I see disturbing signs coming from the company itself.

Specifically, analysts’ profit estimates for AMZN continue to fall. Analysts, on average, had previously expected earnings for the fiscal year to come in at $27.46 per share. Due to AMZN’s lowered guidance, they now forecast $23.49 per share. Moreover, the company’s cloud unit, which  accounts for the majority of its profits, has been hurt by stronger competition from Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG). The cloud unit generated $8.38 billion of revenue last quarter, versus analysts’ average outlook of $8.48 billion .

That should worry investors because they have treated and valued AMZN more like a cloud company than an e-commerce firm.

Other Challenges Facing Amazon Stock

The antitrust investigation that’s likely to include AMZN as well as Alphabet, Apple (NASDAQ:AAPL), and Facebook (NASDAQ:FB) will also weigh on Amazon stock.

But I question whether the probe will hurt AMZN stock over the long-term. Jeffries & Co. analyst Brent Thill estimates the value of the cloud business as a standalone company at $400 billion. I think a spin off of the cloud unit would unlock a significant amount of value. But the probe will breed more uncertainty in the short-term

Amazon has also been blamed by President Trump for the losses of the United States Post Office (USPS). Thus far, the decision by FedEx (NYSE:FDX) to not deliver Amazon packages has probably hurt FedEx more than it has AMZN. Still, I  think FedEx’s move will be worrisome  for AMZN if the President criticizes the retail giant’s use of the USPS again.

None of these challenges will undermine the company’s operations. Still, investors now have a lot more reasons to question the multiple of AMZN stock, making the shares a poor bet in the shorter-term.

The Bottom Line on Amazon Stock

Many signs suggest that the valuation of Amazon stock will drop. First, the inverted yield curve indicates that a  recession is looming. Stock valuations tend to fall when recessions are looming. Moreover, the slowing growth of the cloud unit and the underwhelming growth of other divisions could lead investors to doubt the attractiveness of  Amazon stock at its current levels. .

I also agree with the assertion of another InvestorPlace columnist,  James Brumley that Amazon will emerge as a winner after the slowdown runs its course. I also do not expect AMZN to be broken up, despite President Trump’s feelings about the company.

However, since AMZN does not pay a dividend and the outlook of AMZN stock is dimming, I would not recommend buying AMZN stock at this time.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.


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