For close to a decade, the rule was simple: Amazon.com (NASDAQ:AMZN) stock kept rising. At financial crisis lows, the Amazon stock price dipped below $50. By 2018, it was over $2,000, an increase of more than 4,000%.
It’s not just the size of the gains of AMZN stock that is impressive, but their consistency. From its early 2009 lows to its September 2018 highs, AMZN stock only had one period of underperformance. Shares declined for pretty much all of 2014, but Amazon stock price rallied starting early the next year and didn’t look back for almost four years.
But since reaching an all-time closing high of $2,039 last year, the Amazon stock price has declined 15% in 16 months. A rally in July left AMZN stock less than 1% below last year’s peak. Since then, however, the shares have fallen steadily.
The declines themselves perhaps aren’t that surprising given the stock’s valuation and its past performance. What is surprising is that AMZN stock is falling at a time when the stock market is strong. U.S. equities have rallied in recent months, while Amazon stock has faded. Other mega-cap tech stocks — Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL), and Facebook (NASDAQ:FB) — all sit just a few percentage points from their 52-week highs. AMZN, in contrast, is not far from an eight-month low.
And the weakness makes some sense. I’ve been bullish on AMZN stock for a long time, arguing two years ago that Amazon.com should be the world’s most valuable company. But even bulls have to admit that the stock’s risks are rising. It’s time to pay close attention to those risks.
Why the Amazon Stock Price Has Fallen
For years, skeptics have been calling Amazon stock overvalued. Based on the company’s price-earnings multiple, AMZN stock never was cheap, and it still isn’t. In fact, from a P/E standpoint, it’s likely been the most expensive mega-cap stock in history.
But I’ve long argued that those who analyzed Amazon stock by focusing solely on its P/E multiple were being far too simplistic. Amazon invests in its business. It competes consistently and wholeheartedly on price. Amazon’s earnings, pretty much since its inception, have never reflected its true earnings power.
As I’ve noted repeatedly in recent weeks, growth stocks with high valuations have been hit across the board. From Shopify (NYSE:SHOP) to Roku (NASDAQ:ROKU) to cannabis stocks to recent initial public offerings, the “growth at any price” mindset has come to an end. It’s possible that the weakness of those high-flyers has now spread to AMZN stock, the world’s largest true growth name.
Still, I find it hard to believe that investors suddenly decided that AMZN stock was overvalued or that the same factors that are afflicting mid-cap growth stocks and unprofitable IPOs are driving a selloff of the world’s fourth most-valuable company. Rather, I believe investors are reacting to very real changes surrounding Amazon’s business. And as bullish as I’ve been about AMZN stock in the past, I don’t believe they’re wrong.
Amazon’s Retail Dominance Is Cracking
The justification for AMZN’s high valuation, at least in part, has been based on its sheer dominance. The company unquestionably has transformed the retail sector. Amazon Web Services, its cloud unit, is an increasingly large part of the valuation of Amazon stock. AWS has transformed corporate IT and helped unleash a wave of upstart e-commerce companies across the country and around the world.
But Amazon’s competitors are clearly fighting back. Walmart (NYSE:WMT) has gone all in on ‘”omnichannel,” leveraging its stores and large size to counter Amazon’s convenience and pricing power. Target (NYSE:TGT) has proven that it, too, can compete with Amazon.
Obviously, neither company is growing more quickly than Amazon. Walmart’s U.S. sales increased 3.2% in its third quarter. Target’s revenue rose 4.7% in Q3. In contrast, according to its 10-Q, Amazon’s North America revenue jumped 24% year-over-year in Q3.
That said, the seeming inevitability of Amazon’s dominance of American and worldwide retail is no longer quite intact. More importantly, there’s a real question about just how profitable Amazon can be.
Bulls like myself had assumed that Amazon could become more profitable whenever it chose. That optimism was supported by its 2018 results: the operating income of its North American segment increased 156% year-over-year,. But Amazon now is spending close to $1 billion per quarter — equal to about half of its North American operating earnings — on its one-day shipping initiative.
Is that move a classic case of Amazon always giving customers what they want? Or is it a necessary and permanent response to Walmart, Target, and other brick-and-mortar retailers that can leverage their stores? If the latter is true, margin expectations for Amazon have to come down. Moreover, Amazon’s growth potential might not be quite as extensive as previously thought, and it may not be able to become as profitable as bulls had believed.
AWS and AMZN Stock
AWS, the company’s cloud unit, accounts for a huge part of the market cap of AMZN stock. One analyst estimated that the business is worth $505 billion.
But competitors are gaining on AWS. The success of Microsoft’s cloud business, Azure, is a big reason why MSFT stock has soared. Google, IBM (NYSE:IBM) and Oracle (NYSE:ORCL) are taking aim at AWS as well: Microsoft and Oracle have teamed up in a clear bid to take market share from AWS.
The stepped-up competition has created two risks for AMZN stock. First, Amazon’s cloud competitors have a simple talking point: they’re not competing with most of their customers. Since AMZN is involved in so many businesses, it’s a rival or a potential rival to everyone from grocers to consumer electronics manufacturers to pharmacies to media companies. The rise of other cloud providers allows companies that compete with Amazon in retail or in hardware to use AWS competitors.
AWS also faces a pricing risk. One analyst who’s bearish on MSFT stock has argued for some time that Amazon could undercut Azure on prices for small business. That would be bad news for Microsoft — but it’s not necessarily great for AWS, either. More broadly, there are desperate companies — IBM and Oracle in particular — who need to raise their cloud revenue in order to pivot away from their declining on-premise storage offerings.
The prices of cloud offerings can decline over time And AWS is the business that actually drives the majority of Amazon’s earnings. The company’s international e-commerce business remains unprofitable, and AWS generated $6.6 billion in operating income in the first nine months of the year against $5.1 billion for Amazon’s North American e-commerce segment. Even accounting for the fact that retailers have historically made much more money in Q4 than in the rest of the year, AWS is the biggest source of profits for Amazon right now.
And AMZN stock is trading at over 60 times analysts’ average forward earnings estimate. If the profits and margins of both key units fall, that multiple might drop.
Does AMZN Stock Need a New Catalyst?
My argument is not that AMZN stock should be shorted or even that it’s necessarily overvalued. AMZN is still an unbelievable company: the fact that its revenue has reached $265 billion and is still rising at a 20%-plus clip is an incredible achievement.
I’m nowhere close to buying the argument that Amazon stock is too expensive simply because of its high P/E multiple. Its margins will rise over time. One-day shipping costs will be offset by growth and potentially by cost reductions as the company continually improves its infrastructure.
Rather, the main worry at this point is that Amazon and AMZN stock have seemed almost bulletproof for a long time. But its competitors are stepping up, so the path to worldwide dominance by AMZN and a higher Amazon stock price don’t seem as easy as they appeared to be last year.
The weakness of AMZN stock of late highlights that fear There’s an obvious worry that maybe one-day shipping went too far or shows that the company’s edge over the rest of retail wasn’t quite as powerful as investors thought it was. It doesn’t seem a coincidence that Amazon stock price has gone in the opposite direction of its mega-cap tech peers since one-day shipping was announced.
In the near-term, Amazon may need something else to get investors excited. Its peripheral businesses are not doing the trick. The acquisition of Whole Foods has gone nowhere. Amazon is way behind in streaming and in music. Echo and Alexa have been winners, but they may not be moving the needle of Amazon stock.
With AMZN stock looking likely to re-test its support around $1,700, it’s difficult to see what will get investors excited about Amazon stock. Or perhaps the problem is slightly different: investors are excited. But as the stock charts show, they’re excited about Microsoft, Target, Walmart, and Disney (NYSE:DIS), not AMZN stock. That alone might be the biggest problem for Amazon stock at the moment.
As of this writing, Vince Martin has no positions in any securities mentioned.