Amazon (NASDAQ:AMZN) is a tech giant that thrived in 2020 as the demand for stay-at-home stocks was strong. But with Jeff Bezos stepping down as Amazon’s CEO this year, there are many challenges for Amazon stock. And while the majority of Wall Street analysts tend to be positive about Amazon stock, I have some important reasons to be a contrarian.
2020 was a year to remember (or maybe to forget) as the pandemic disrupted our lives in a negative and unprecedented way. But for some businesses, the pandemic was an opportunity to thrive. Amazon stock was one of the companies that saw its business booming in 2020. Shares rose from about $2,100 per share in February 2020 to a 52-week high of $3,552 per share, or an increase of about 70%.
The big question is after this strong rally is: is Amazon stock worth buying now, with major U.S. stock indices near their record highs?
For me, the answer is based on a plethora of facts. Amazon is a great company, but its stock does not look great to buy at current price levels.
Looking at Marketwatch, the majority of analysts are very optimistic about Amazon stock. 43 analysts give a buy recommendation, five analysts an overweight rating, only two analysts a hold rating, and no analysts give an underweight or sell rating.
So why am I a contrarian? The answer is based on valuation, I believe the stock is highly overpriced.
Amazon Business Model: A Well Diversified Model that Generates Cash
Amazon has a well-diversified business model. In 2020 Amazon had $386 billion in revenues and $21.3 billion in net profits. Amazon’s famous ecommerce segment contributes the majority of its revenues, followed by physical stores, Amazon AWS, subscription services, other third-party seller services, and last but not least advertising.
It is a business model that has many advantages. One of the financial metrics that Amazon excels at is generating cash. It has strong positive free cash flows, which have increased for the past three consecutive years. In 2018 the company reported a free cash flow of $17.3 billion, and in 2020 free cash flow of $31 billion. Operating cash flow is strong too. And revenues of $280.52 billion in 2019 increased 37.62% in 2020 to $386.06 billion.
If you want to speak with facts and not just opinions, then another positive argument in favor of Amazon stock is that in 2020 the net income growth was 84.08%, higher than the revenue growth of 37.62%. This is very positive — but at the same time, let’s not forget that 2020 could well be what we call an outlier in statistics. In this case, an outlier means a one-time number that distorts the actual trend of previous years.
I believe that this sales growth and net income growth were maybe too high, and that in 2021, it will be tough for Amazon to continue this level of growth.
Take for instance years 2017, 2018, and 2019. In 2018 Amazon had a sales growth of 30.93% compared to 2017. In 2019 there was a slowdown to 20.45% compared to 2018. And in 2020 with the pandemic, there was a surge to 37.62%. For me, it will be very hard for Amazon to have even higher growth in 2021.
Will Jeff Bezos Stepping Down as CEO Be a Catalyst?
The answer is both yes and no. When the charismatic Steve Jobs stepped down as CEO of Apple (NASDAQ: AAPL) and Tim Cook took over, there were worries about the future of Apple. And history proved that Tim Cook has been a fine choice, as Apple shares have prospered.
Jeff Bezos is also a charismatic leader. But I believe that he has already set in place strong business morals and a vision for Amazon, and his successor most probably will continue to focus on growth and solid financial performance for Amazon.
Amazon Stock: Why its Valuation is too Stretched
The P/E ratio (TTM) of Amazon stock is 77.69. While the P/E ratio by itself does not say much about the valuation of any stock, it is the trend of it and its comparison with the P/E ratios of the industry and sector of any company that is most useful.
According to Zacks, Amazon will continue to be a growth stock. The expected EPS growth for the next three-to-five years is 26.90%. The forward P/E ratio is estimated to 65.70.
What are the key financial metrics that make Amazon expensive at a current stock price of about $3,250 per share? For a start the PEG ratio of 2.44. A PEG ratio of under 1.0 indicates the stock may be relatively undervalued.
Then the comparison of key financial metrics of Amazon stock with those of its retail sector and internet, mail order, and online shops industry with data from CSIMarket.
The P/E ratio (Q4 TTM) for Amazon is 76.5. For the industry, sector, and S&P 500 the figures are 62, 53.94, and 49.81 respectively.
What about two other important valuation metrics such as the Price-to-Sales ratio and the Price-to-Book-Value ratio?
The price to sales (Q4 TTM) ratio for Amazon is 4.24. The industry, sector, and S&P 500 ratios are 4.16, 1.33 and 3.57 respectively.
The price to book (Q4 MRQ) ratio for Amazon is 17.55. The industry, sector, and S&P 500 ratios are 17.14, 9.27, and 5.97 respectively.
This shows that on a relative valuation, Amazon stock is expensive.
Another argument that makes me skeptical and a contrarian about Amazon is that despite the surge of growth in revenues and net income in 2020 due to the pandemic, the profitability margins did not expand as much as I would expect. Data from Morningstar shows that in 2019 net margin fell to 4.13% from 4.33% in 2018 and only increased to 5.53% in 2020. If 2020 was an outlier for statistics, then I expect in 2021 the net margin to decline from 5.53%.
In other words, it’s a great growth stock, but its valuation to me is rich. Amazon stock is flat so far in 2021, and this may indicate that it has lost its momentum.
On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.