Perceptions about Amazon (NASDAQ:AMZN) seem to have changed. The Seattle-based tech and retail conglomerate has remained a favorite over the years as it pioneered e-commerce, and later, the cloud industry.
However, some competitors have begun to catch up with the company. As a result, profit growth has fallen as it seeks to push back against threats from its peers. Amazon should remain a winner long term, but its current position in the market has made it difficult to trade.
The Buy Case Has Become More Uncertain
For the sake of full disclosure, I recommended Amazon about a month ago. Since that time, it has risen from the $1,735 per share range to about $1,790 per share. Also, I had pointed out in an earlier article that analysts had predicted earnings increases to average 83% per year for the next five years. Such a growth rate appeared almost to defy the law of large numbers, and is difficult for a company with nearly an $898 billion market capitalization.
However, the case for Amazon has become more uncertain, as estimates have come down. As the costs of switching to one-day shipping grow more apparent, Wall Street now forecasts lower profits. Today, analysts predict 28% growth per year on average for the next five years — which is still an impressive feat for such a large company.
Collectively, this may delay the recovery in Amazon. It now trades at a forward price-to-earnings (P/E) ratio of about 66. Such a multiple justifies 83% earnings growth. Still, this takes the price-to-earnings-to-growth (PEG) ratio to more than 2.35 from a long-term perspective. This seems high if the forecast of 28% earnings increases proves true.
Should Traders Buy or Wait?
Nonetheless, investors have a long history of showing patience with Amazon. For one, it has built a compelling retail operation. Its success prompted some to predict the demise of retail giants such as Costco (NASDAQ:COST), Walmart (NYSE:WMT) and Target (NYSE:TGT). Nonetheless, retail successes have come at the expense of Amazon’s investors, as profit margins remained low when they existed at all.
Moreover, even the cloud unit — which drives the majority of its profits — has faced competitive pressure from Microsoft (NASDAQ:MSFT). After Amazon lost the $10 billion contract for the so-called “war cloud” to the software giant, the battle for cloud supremacy has become more intense than ever.
However, Amazon has built its conglomerate on thinking long term. I think this bodes well for the company’s investors, eventually. This stands in stark contrast to the company I call the “20th century Amazon,” Sears (OTCMKTS:SHLDQ). Sears focused primarily in the short term during its last few decades, and we all know what happened to them.
This situation makes the immediate future hard to predict. Indeed, Amazon has seen higher forward P/E ratios than 66. For this reason, I could see traders buying. Still, with a PEG ratio exceeding two, it has become overvalued for the moment. Although I believe this equity will move much higher in the long term, I also would not blame investors for holding out for a lower price.
Final Thoughts on Amazon
The biggest problem Amazon investors face is how to trade the stock. Until recently, forecasted profit growth appeared to support a P/E ratio that most any other company its size could not justify. However, rising threats to both its retail and cloud operations have forced the company to take measures that will reduce short-term profits. With a forward multiple near 66, traders seem to question whether the company can justify such a valuation amid lower profit growth.
Investors have shown patience with Amazon throughout most of its 22-year trading history. Therefore, seeing traders bid the stock higher at these levels would not surprise me. However, I think traders should stop buying as Wall Street adjusts to lower levels of profit growth.
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.
